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The Inflation Update: January 2002 Columbus,
Ohio Consensus forecasts for both the headline and traditional core CPI measures were on the mark this month, with both measures rising by 0.2 at a monthly rate – 2.0% and 1.9% at an annual rate (a.r.), respectively. Meanwhile, however, the Median CPI computed by the Federal Reserve Bank of Cleveland increased by 0.3, 3.7% (a.r.). The CPI excluding food and energy rose 2.6% over the past 12 months, while the Median CPI is up 3.9% from January 2001. Both measures of the inflation trend seem to be subsiding very slightly. But the apparent surface calm of the aggregate indices is masking particularly violent turbulence below in the components. To see, we need only go down one level, splitting the ex. food and energy core into its goods and services components. Core goods (commodities excluding food and energy commodities) fell 4.1% (a.r.) for the month, while core services (services excluding energy services) rose by 4.6% (a.r.) from December 2001 to January 2002. Over the past 12 months, things are somewhat less dramatic, with core goods prices falling a modest 0.8% and core services rising a slightly more tempered 3.9%. At first blush, this looks like a repeat of 1997-1998, when the worldwide slowdown precipitated by the Asian crisis created a glut in production capacity that put downward pressure on prices for some time. Yes, it is true that capacity utilization, both domestic and international, is low. But as was the case several years ago, this is the capacity to produce goods! Services are another story, and here things do not look so rosy. To see why I’m worried, consider the following simple calculation. Let’s begin by accepting the claims about lack of pricing power, and assume stability for the prices of core goods. For services, though, we need to infer the trend by looking at the behavior of the important components. Over the last year, owner equivalent rent is up 4.5% and medical care rose 4.7%. Overall, core service prices have been accelerating somewhat and now seem to be rising at a rate of about 4.6%. Next we can use the actual CPI weights to average these two numbers together. Goods account for 30% of the ex. food and energy core, with services taking up the remaining 70%. Simple arithmetic leads to my troubling (alarmist?) conclusion that inflation is on its way over 3%: (0.7x4.6+0.3x0)=3.2. To make matters worse, the possibility of a global recovery combined with a moderate dollar depreciation present risks that inflation could go even higher. I simply do not subscribe to the notion the slowdown has somehow generated sufficient slack resources to push inflation down over the next year. I see no evidence in the inflation statistics to suggest that service price inflation is somehow moderating. In fact, most of the information we have available is pointing the other way. Consumer Price Inflation, Various
Measures
Note: There were two major revisions to the CPI data this month. Following the standard pattern, the BLS revised the seasonal factors going back several years. This had a very minor impact on past inflation patterns. In addition, this month’s release marked the introduction of the new biennial revision in the expenditure weights. This is a welcome change that will improve the accuracy of the CPI. Background work over the past few years suggests that this technical adjustment will have only a minor and unpredictable impact on calculated inflation. For
previous updates, as well as my occasional essays on current policy
issues, (Note:
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