The Inflation Update

The Inflation Update: November 2002
Stephen G. Cecchetti
17 December 2002

It is hard to see how anyone’s view would be changed by this morning’s inflation report. For the majority that sees inflation stable and falling, things looked stable and falling. For the minority that sees inflation rising, there are some indications that inflation is rising. The first group will point to the all-items CPI rising at an annual rate of 1.3% for the month, with the CPI excluding food and energy going up 1.9%. And over the last 12 months, things are looking pretty good. As energy prices have fluctuated, headline inflation has been a fairly steady 2.2% and core inflation excluding food and energy rose a modest 2.0%.

How can numbers like these make anyone think inflation could possibly be on its way up? Well, there are a few things. First, there are the alternative measures of inflation and then there is the detail in the report. The Median CPI computed by the Federal Reserve Bank of Cleveland rose a modest 1.7% for the month, but is up 3.0% for the last 12 months. And turning to the detail, consider medical care and housing costs. Medical care inflation is clearly rising – up 6.8% (a.r.), well above it’s 5% average for the year. And while owner equivalent rent took a bit of a breather last month, rising 1.7% (a.r.), the index is up 3.4% for the last 12 months. Remember, the owner equivalent rent index is based on a rental survey that behaves very differently from the prices of homes themselves. During booms, like the 1990s, homeownership rates rise, and so rental vacancy rates rise too. This puts downward pressure on rents, and ends up depressing the OER. As the boom abates, rents catch up, driving OER up more than even a careful observer of the housing market would suspect. Even if housing prices start to fall, this will not translate into a decline in the OER.

I continue to be convinced that unless the stance of Federal Reserve policy is changed fairly soon, the result will be higher inflation. More than anything else, this month’s CPI increases my uncertainty about how soon interest rate increases need to come in order to insure that inflation stays low. It certainly looks like the FOMC has at least until mid-2003 before they have to start raising the funds rate.

Reflecting over the past year, I am struck by the resiliency of our economy to the shocks that have hit us. Who would have thought that in the four quarters after September 11, 2001 the U.S. economy would grow at a rate above 3%, inflation would be 2% and unemployment would remain at or below 6 percent? Every so often I speculate about what the response to such readings would have been 10 years ago – they are all better than the average from 1980 to 1995. I am very surprised that such extraordinary macroeconomic outcomes have been met by such defeatist rhetoric. The only explanation I can offer is that we continue to be intoxicated by the manic performance of the late 1990s when growth was over 4 percent per year. Those times really were too good to be true, and we need to be more humble in our expectations.

I hope that the natural recuperative powers of our economic system, and the far-sightedness of our policymakers serve us as well in the coming year as they have in the last.

Happy Holidays!

Consumer Price Inflation, Various Measures
(Through November 2002, all data at an annual rate)

Previous	All Items CPI	CPI ex Food & Energy	Median CPI
1 Month	1.3	1.9	1.7
3 Months	2.2	1.7	2.6
6 Months	2.2	1.9	2.9
12 Months	2.3	2.0	3.0
12 Months ending November 2001	1.9	2.7	4.0

For previous updates, as well as my occasional essays on current policy issues,
Please visit my home page:
Steve Cecchetti's Homepage
(Note: If you have trouble viewing the tables, you may prefer looking at the pdf file
The Inflation Update: November 2002 PDF Format
These also include the table used to construct the Median CPI.)

Detail for Computation of the Median CPI
November 2002

Component	Annualized 1-month % change	Relative Importance	Cumulative Relative Importance
Fresh fruits and vegetables	23.4	0.9	0.9
Tenants' and household insurance	16.4	0.4	1.3
Motor vehicle insurance	14.6	2.4	3.7
Public transportation	11.8	1.2	4.9
Fuel oil and other fuels	10.4	0.2	5.1
Lodging away from home	8.4	2.7	7.8
Meats, poultry, fish, and eggs	7.7	2.2	10.0
Medical care services	7.1	4.6	14.6
Motor vehicle maintenance and repair	6.5	1.4	16.1
Medical care commodities	5.2	1.4	17.5
Education	4.8	2.9	20.3
Dairy and related products	4.4	0.9	21.2
Motor vehicle fees	4.3	0.6	21.8
Water and sewer and trash collection services	4.3	0.9	22.7
Rent of primary residence	4.3	6.6	29.2
Men's and boys' apparel	4.1	1.1	30.3
Miscellaneous personal services	4.0	1.6	31.9
Personal care services	3.9	0.9	32.8
Other food at home	3.8	1.8	34.6
Motor vehicle parts and equipment	3.4	0.4	35.0
Alcoholic beverages	2.6	1.0	36.1
Owners' equivalent rent of primary residence	1.7	22.6	58.6
Food away from home	1.3	6.3	64.9
Cereals and bakery products	0.6	1.3	66.2
Recreation	0.0	6.0	72.2
Tobacco and smoking products	-0.5	1.0	73.2
New vehicles	-0.9	5.0	78.2
Household furnishings and operations	-0.9	4.8	82.9
Footwear	-1.0	0.9	83.8
Infants' and toddlers' apparel	-1.9	0.2	84.0
Gas (piped) and electricity	-2.6	3.4	87.4
Motor fuel	-2.8	3.0	90.4
Personal care products	-3.1	0.7	91.1
Miscellaneous personal goods	-5.0	0.2	91.3
Communication	-5.1	3.0	94.4
Nonalcoholic beverages and beverage materials	-8.2	1.0	95.3
Women's and girls' apparel	-8.9	1.8	97.1
Car and truck rental	-10.6	0.1	97.2
Jewelry and watches	-13.5	0.4	97.6
Used cars and trucks	-15.6	2.1	99.7
Processed fruits and vegetables	-18.3	0.3	100.0

Detail for Computation of the Median CPI