CEPR

November 2016 (Prices Byte)

By Nick Buffie

Excluding Shelter Costs, Core Inflation Is Just 1.2 Percent

Earlier this morning, the Bureau of Labor Statistics (BLS) released new data on the Consumer Price Index (CPI), one of the two main measures of consumer inflation. Comparing the average price level from the past three months (August, September, and October) to the average price level from the same three months of 2015, we see that inflation comes to 1.4 percent over the past year. This is well below the 2.3 percent rate that is consistent with the Fed’s inflation target, and also happens to mark a deceleration in price growth from previous months. Using the same methodology, “core” inflation — which excludes volatile food and energy prices, and thus serves as a good predictor of future inflation — comes out to 2.2 percent. If we look at price growth over the last 12 months (October 2015 to October 2016), the core inflation rate comes out to 2.1 percent.

Unusually small price increases were observed for a number of goods and services. Automobile items have generally become cheaper. Used cars and trucks fell 4.1 percent in price over the past year, while the prices of new ones rose just 0.2 percent. Tires fell 0.4 percent in price.

There were also price drops for a large number of goods related to leisure. The prices of “recreation commodities” fell 4.0 percent, while the prices of video and audio products decreased 14.5 percent; both were the largest ever year-over-year price drops ever recorded for these items. Toys, games, hobbies, and playground equipment also experienced a record-high drop, with prices falling 7.8 percent.

Finally, land-line telephone services experienced no price increase, with costs falling 0.2 percent over the past year. This too was the largest decrease ever recorded by the BLS. It would be tempting to attribute this price drop to a shift in demand away from landlines and towards cell phones, but that is clearly not the whole story since prices fell even more (3.2 percent) for wireless telephone services. Also, it is worth noting that information technology commodities — which includes personal computers, computer software, telephone hardware, etc. — saw prices fall 8.3 percent over the past year.

Of course, there are areas in which prices are clearly rising, most notably when it comes to drug prices and rents. Last month, the BLS reported that drug prices had experienced a record-breaking annual price increase, and that trend appears to be continuing. Drug prices have risen 5.2 percent since October of last year. This is driven purely by rising costs for prescription drugs (which are up 7.0 percent), since nonprescription drugs actually saw their prices decrease 1.4 percent over this period. Note that the CPI only tracks out-of-pocket drug spending, so these increases aren’t being picked up by the insurance companies themselves.

Shelter prices are up 3.5 percent over the last 12 months; rent of primary residence — a measure looking at where people live permanently, which excludes stays at motels and hotels, school boarding costs, etc. — is up 3.8 percent. This single factor is actually the primary driver of today’s inflation. Excluding shelter costs, total inflation was just 0.7 percent over the past year, while core inflation was 1.2 percent. This explains a large part of the divergence between the Consumer Price Index and the Personal Consumption Expenditures (PCE) index, the latter of which is used by the Federal Reserve to determine if it is hitting its 2 percent inflation target. The two indexes include somewhat different items in their overall measure of inflation, with the CPI placing far more emphasis on shelter costs than the PCE does. Therefore an increase in shelter costs will push up the CPI much more than the PCE, and shouldn’t lead to worries that the Fed will overshoot its 2 percent inflation target anytime soon.

The Producer Price Index showed an inflation rate of just 0.8 percent over the last 12 months. The prices of goods rose 0.3 percent, while the prices of services rose 1.1 percent. The Import-Export price indexes showed a moderate amount of actual deflation. Import prices fell 0.2 percent and export prices fell 1.1 percent over the past year. Moreover, these drops aren’t being driven by volatile food and energy prices — excluding food and fuels, import prices are down 0.7 percent, while export prices are down 0.9 percent.

On the whole, the new data indicate that inflation is low and possibly decelerating, meaning that the Fed should be more worried about undershooting rather than overshooting its inflation target. Moreover, what little inflation there actually is happens to be driven primarily by rising shelter costs, which won’t push up inflation very much in the PCE. While these results could reverse themselves in future months, right now they point to the Fed keeping interest rates low.