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The Inflation Update: August 2000 Stephen G. Cecchetti 16 September 2000
Trend inflation continues to creep upward. While the headline CPI fell -0.7% (at an annual rate) from July to August, measures of core inflation rose at rates slightly higher than in recent months. The CPI excluding food and energy rose 2.7% (a.r.) while the Median CPI computed by the Federal Reserve Bank of Cleveland increased by 2.9% (a.r.). Both statistics continue their upward trend of the past year, and it now appears that core inflation is closer to 3% than it is to 2½% The deviation of the headline CPI from the core measures is a consequence of the very dramatic 6% fall in motor fuel prices for the month. This alone accounted for 2 of the 3.4 percentage point difference between the annual rate change in the headline and ex food and energy CPI. This month's report has two new developments worth mentioning. These are the rise in medical care costs and the acceleration in owner equivalent rent (OER). Overall, medical care costs rose 5.2% (a.r.) for the month, and 4.3% for last 12-months. Recent news about the financial difficulties faced by medical care providers suggests this may become an increasingly important source of price pressures. Since housing prices have been rising very rapidly, many people have been wondering why owner equivalent rent was still rising at a modest pace. With this month's rise of 3.7% (a.r.), and 2.8% over the past 12 months, OER inflation may finally be reflecting the price pressures we have been seeing in real estate for some time now. As I have emphasized in a number of my past updates, OER is one of the best indicators of future inflation trends. I find this increase particularly troubling.[1] With the many indications that the growth rate of the overall economy is slowing, should we worry about this apparent increase in inflation? Or, is this just a temporary blip? My view is that we are at a particularly perilous point. The danger comes from the possibility that the combined increase in energy prices and medical care costs represent rises in the producer costs, and could be pushing us into a period of stagflation similar, but less extreme, than what we saw in the middle and late 1970s. In the same way that oil price declines and low medical care inflation contributed to the low inflation and high growth of the late 1990s, the events of the past few months could well create the opposite conditions. To the extent that the current slowdown is the consequence of supply and cost shocks, it portends inflation increases rather than declines, and the appropriate policy response will be an interest rate increase rather than a decline. Without a policy tightening, we risk allowing increases in expectations, wages and consumer prices to be built into inflation trends and that will be very costly to drive out of the system in the future.
Consumer Price Inflation, Various Measures
[1] OER has a lower and medical care a higher weight in the Personal Consumption Expenditure deflator. As a result, it seems likely that the PCE-based inflation index will rise by more than the CPI. See my Occasional Essay No. 5 "The U.S. Inflation Alphabet: A Primer," for a discussion of the differences between the CPI and PCE indices.
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/
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