The Inflation Update

The CPI report released on February 20 suggests that inflation has bottomed out. The CPI excluding food and energy was up 1.9% (annual rate) for the month, while the Median CPI computed by the Federal Reserve Bank of Cleveland rose 1.6% (a.r.). For the past 12 months these core measures are up 1.1% and 2.0% respectively.

Two things stand out in the report. First, the owner equivalent rent rose 1.6% for the month, and up only 1.9% for the past year. Inflation in the perennial median good (see the detailed table below) appears to have stabilizing and could be on the way back up. The second thing to notice is that core goods prices (commodities excluding food and energy commodities) was flat for the month. Goods prices have been falling consistently for the past 2 years. If this trend has stopped, it means that inflation is going up.

We can get some sense of where inflation might be going from the following simple computation. The CPI excluding food and energy is roughly 30% goods and 70% services. Core services prices are currently rising at a rate of roughly 2¾% per year. Assuming that core goods prices remain stable, this means that the inflation trend heading toward 0.7x2¾=1.9%. My estimate is that this is where we are right now. As increases in housing prices find their way into the rental measured used in consumer price measures, aggregate inflation will rise further.

What this means is that if the Fed is serious about keeping inflation below 2%, they need to get to work and start tightening very soon. The Committee’s apparent fixation on the jobs data makes this very unlikely. My sense is that we will not see any increase in the Federal Funds Rate target this calendar year. If this is true, we can expect inflation to rise to at least 2½% before stabilizing again.

Consumer Price Inflation, Various Measures
(Through January 2004, all data s.a. at an annual rate)

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Detail for Computation of the Median CPI
January 2004
Component	Annualized 1-month % change	Relative Importance	Cumulative Relative Importance
Car and truck rental	-25.5	0.1	0.1
Fresh fruits and vegetables	-24.9	1.0	1.1
Footwear	-9.6	0.8	1.9
Women's and girls' apparel	-8.2	1.7	3.6
Other food at home	-4.3	1.8	5.4
Dairy and related products	-4.1	0.9	6.2
Lodging away from home	-2.9	3.0	9.2
Used cars and trucks	-1.8	2.0	11.2
Communication	-1.4	3.1	14.4
Men's and boys' apparel	-1.0	1.0	15.4
New vehicles	-0.9	4.9	20.3
Meats, poultry, fish, and eggs	0.0	2.4	22.6
Recreation	0.0	5.9	28.6
Motor vehicle maintenance and repair	0.6	1.4	29.9
Cereals and bakery products	1.2	1.2	31.1
Miscellaneous personal goods	1.4	0.2	31.3
Medical care commodities	1.4	1.5	32.9
Owners' equivalent rent of primary residence	1.6	23.6	56.5
Rent of primary residence	1.7	6.2	62.7
Personal care services	1.9	0.7	63.4
Infants' and toddlers' apparel	2.0	0.2	63.5
Public transportation	2.3	1.1	64.6
Motor vehicle insurance	3.1	2.5	67.1
Personal care products	3.2	0.6	67.7
Motor vehicle parts and equipment	3.4	0.4	68.1
Nonalcoholic beverages and beverage materials	3.5	0.9	69.0
Medical care services	3.5	4.6	73.6
Miscellaneous personal services	3.8	1.5	75.1
Food away from home	4.0	6.2	81.3
Alcoholic beverages	4.5	1.0	82.3
Household furnishings and operations	4.9	4.5	86.8
Tenants' and household insurance	5.4	0.4	87.2
Water and sewer and trash collection services	6.2	0.9	88.1
Education	6.2	2.9	91.0
Tobacco and smoking products	6.8	0.8	91.8
Gas (piped) and electricity	20.8	3.7	95.5
Processed fruits and vegetables	33.0	0.3	95.7
Jewelry and watches	33.8	0.3	96.0
Motor vehicle fees	106.7	0.5	96.5
Fuel oil and other fuels	119.1	0.2	96.7
Motor fuel	154.6	3.3	100.0

Detail for Computation of the Median CPI

January 2004