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The Inflation Update: March 2001 Stephen G. Cecchetti 17 April 2001
Sometimes you wish things would
turn out differently – even when you predicted it.
That’s surely the case today, as the inflation report has come in
pretty much the way I thought it would (and have been writing here for
some months now). This
morning’s CPI cannot give much solace to FOMC members who are hoping
that they will have sufficient room to reduce interest rates by as much as
another 175 basis points as a way of addressing the slowdown in the
economy. Such
“stimulative” action is now looking increasingly perilous, as it risks
allowing inflation to become established at level thought by most
economists to be unacceptable in the long run.
There is now the distinct possibility that the inflation trend
exceeds 3%.
The apparently tame appearance of
the all-items CPI, which rose at less than a 1% annual rate in March, is a
consequence of a dramatic one-month decline in energy prices, which fell
by 2% for the month (or –22% at an annual rate).
But there is turmoil beneath this calm surface, as measures of core
inflation show steady acceleration. For
the month, the CPI excluding food and energy was up 2.6% (a.r.), while the
Median CPI computed by the Federal Reserve Bank of Cleveland increased a
whopping 4% -- it’s average for the past 3 months! Over the past 12 months, the headline CPI and the CPI
excluding food and energy rose by 2.9% and 2.7% respectively, while the
Median CPI is up 3.4%. But
more importantly, all of these measures indicate that inflation has been
allowed to creep up to a new, higher trend.
Just over one year ago, the CPI excluding food and energy was
rising at a rate of around 2%. As if all of this weren’t
troubling enough, the detail of this months report contains more ominous
news – owner’s equivalent rent (OER) rose at a 4.2% annual rate! For most of the past few years, this measure of the implied
rent to homeowners has gone up at a rate of less than 3% per year.
As I mentioned in my May
2000 update there are reasons to believe then that the OER was
understated, and that there would be some payback when the economy slowed.
It looks like we are seeing it now.
This is a particularly serious problem, as OER tends to be very
persistent. In other words,
we may see these outsized “rent” increases for several more months
yet. But the large OER increase isn’t
the end of the March CPI story. The median good this month was medical
care commodities. This, as
well as medical care services (which rose 4.6% for the month), are also
rising at an increasing rate suggesting that NIPA measures of inflation,
such as the closely watched chain-weighted index for personal consumption
expenditures may show a pick-up as well.
The main difference between CPI and PCE inflation is that the
latter measure weights medical care more heavily, while down weighting
housing. (See
The U.S.
Inflation Alphabet: A Primer for a detailed
discussion. Also,
it is worth noting that the PCE uses a different medical care services
index, based on the PPI measure of health services inflation, that has
been rising at a somewhat less rapid rate than it’s CPI counterpart.) So what’s the bottom line on
this month’s CPI report? Private-sector
forecasters are saying that the slack in the economy will bring core
inflation back down below 2½% next year, even as the Federal Funds rate
is reduced to 4% (or less). This
is an unjustifiably optimistic forecast, in my view.
Combine recurring supply shocks in the energy area with consumption
growth above 2%, and we have a mixture that will likely continue to propel
prices upward. Consumer prices are looking at the distinct possibility of
showing growth above 3% for the foreseeable future. Consumer Price Inflation, Various
Measures (Through March 2001, all data at
an annual rate)
For previous
updates, as well as my occasional essays on current policy issues, Please visit
my home page: http://economics.sbs.ohio-state.edu/cecchetti/ (Note:
If you have trouble viewing the tables, you may prefer looking at
them in html at http://economics.sbs.ohio-state.edu/cecchetti/pdf/inf04_01.htm or you can
download the pdf file http://economics.sbs.ohio-state.edu/cecchetti/pdf/inf04_01.pdf)
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