June 13, 2008 (Prices Byte)

By Dean Baker

"Medical care inflation is down from 5.2 percent in 2007 to 1.8 percent in the last quarter."

The overall CPI rose by 0.6 percent in May, driven by a 4.4 percent jump in energy prices. This brings the annual rate of increase in the CPI for the last quarter to 4.9 percent, up from 4.2 percent over the last year. Inflation in the core CPI is still relatively contained, coming in at 0.2 percent. The annual rate of increase in the core has been just 1.8 percent over the last three months, down from 2.3 percent for the last year.

The low inflation rate in the core index is striking given the price pressures at earlier stages of production. The May producer price index will not be released until next week, but the April data showed inflationary pressures at all levels, in both the core and overall indices.

The core component of the finished goods index rose by 0.4 percent in April. It has now risen at a 5.0 percent annual rate over the last quarter, compared to a 3.0 percent rate over the year. The core finished consumer goods index has risen even more rapidly, increasing at a 5.4 percent annual rate over the quarter, compared to a 3.6 percent rate over the last year.

Inflation at earlier stages has been even higher. The core intermediate goods index rose by 1.2 percent in April, bringing its annual rate over the prior quarter to 12.4 percent, up from a 5.8 percent rate over the last year. The core crude goods index jumped 7.9 percent in April, bringing the annual rate of inflation over the quarter to 76.8 percent. This compares with a 24.6 percent rate over the last year.

However, these price increases are not showing up at the retail level. For example, the women and girls’ apparel component of the CPI has fallen by 5.0 percent over the last year. It has dropped by just 0.2 percent in the finished goods index. The passenger car component of the finished goods index has increased by 2.1 percent over the last year; the new vehicles component of the CPI has fallen by 1.2 percent over this period. The pharmaceutical preparations component of the finished goods index rose by 6.6 percent over the last year, while the prescription drug component of the CPI has risen by just 2.8 percent.

These sorts of gaps are difficult to reconcile. They suggest either an extraordinary squeeze in profit margins at the retail level or some serious problems in measurement in these indices. There may be a bit of both. Clearly, many retailers are hurting, so the margin squeeze is real. But, it is possible that the finished goods index is not picking up various manufacturers’ discounts/rebates and, therefore, overstating the true rate of inflation at the wholesale level.

Perhaps the most striking item in the CPI is the continued containment of medical care costs, which rose by just 0.2 percent for the second consecutive month. The annual rate of increase in this component over the last quarter has been just 1.8 percent. By contrast, medical care inflation was 5.2 percent over calendar year 2007. It is difficult to see an explanation for such a sharp slowing in medical care costs.

Owners’ equivalent rent, which accounts for 31.3 percent of the core CPI, rose by just 0.1 percent in May. This component has risen at just a 2.0 percent rate over the last quarter as the housing glut continues to depress prices. The rent index rose by 0.2 percent, bringing the rate for the quarter to 2.9 percent. The difference is explained by the inclusion of utilities in the rent index.

On the whole, the May price data present a rather worrying picture. The sharp jump in energy prices means that inflation is substantially outpacing wage growth. This is reducing workers’ purchasing power at a time when their home equity is rapidly disappearing. The one positive part of this picture is that inflation in food and energy has not yet shown up as inflation in the core components of the CPI, even though core inflation is higher at earlier stages of production.

Dean Baker is co-director of Center for Economic and Policy Research in Washington, DC. CEPR's Prices Byte is published each month upon release of the Bureau of Labor Statistics' reports on the consumer price and the producer price indexes. For more information or to subscribe by fax or email contact CEPR at 202-293-5380 ext. 102, or morgavan [at] cepr [dot] net.