Inflation Relief? Not Likely

Recent inflation reports have created much market enthusiasm. The moderation shown in the October consumer price index (CPI) release pushed the Dow-Jones industrial stock index up some 1200 points in a single trading session. CPI news for November, though evoking a less enthusiastic market response, gave investors reason to hope that the moderating inflation trend was gaining momentum and that perhaps soon the Federal Reserve (Fed) might ease up on raising interest rates. If such thinking really is gaining the ascendency, investors will likely face disappointment. The fact is that inflationary pressures such as the nation has faced for more than a year now do not dissipate quite so quickly.

The CPI’s headline figures have offered encouragement to be sure. The overall CPI rose 0.4% in October and a mere 0.1% in November. Though the November figure is well within the Fed’s acceptable range, the 7.1% consumer price rise over the past 12 months remains uncomfortable from every perspective. Though the moderation is undeniable, the details should curb people’s enthusiasm.

They make clear that inflationary pressure remains widespread. Food prices rose 0.6% in October and 0.5% in November, a slight moderation from earlier months but still almost a 7.0% annual rate of increase and hardly a point of comfort for America’s homemakers. What is more, the price of shelter overall – both ownership and rentals – rise at a just under a 9% annual rate during these two months, showing no moderation at all from prior months. Because these two items alone constitute more than 46% of the average American’s household budget, the concept of relief can only be described as stretching it.

Although the so-called “core” inflation measure – all items excluding food and energy – did moderate to a 3.0% annual rate of increase, that was due almost entirely to one item — a tremendous 5.2% drop in the price of used cars and trucks in just these two months. If such declines promised to last, the news might be significant, but with the price of new vehicles still up more than 7.0% percent over the last 12 months, it is hard to see the price of used vehicles falling very much longer, certainly not at recent rates.

A further warning lies in how inflation measures behave over time. History makes clear that the variation in inflation measures month to month gets wider when inflation on average is high. Take the period of the last great inflation between 1973 and 1981. The record of rolling 12-month inflation measures during that terrible time shows a high measure of 14.6% in March of 1980 and a low of 5% in December of 1976, with the measures bouncing between these bounds throughout that time. That is a 9.6 percentage point difference. By contrast, during the low inflation period of similar duration at the beginning of this century, the high inflation was 3.6% (November of 2004), and the low was a deflation of 2.0% (July of 2009). That is a difference of only 5.6 percentage points, barely over half the difference seen in the earlier, high-inflation period.

A stronger warning still is how the inflation measures bounce around from month to month regardless of the longer-term averages. Take 2003, for example, a year when the average came in right on the Fed’s preferred 2.0% annual rate. The year began with a 0.5 percent CPI jump in January, a 6.1% annual rate of advance. A focus on that month’s data might have caused concern. In April and May, however, the Labor Department reported monthly CPI declines of 0.3% on average. Too close a focus on those figures might have raised fears of outright deflation. Since the year came in right on target, either focus and the attendant fears it brought would have been dangerously misplaced, either for policy makers or investors or citizens.

None of this is to ignore recent figures. Nor does this discussion assert that history repeats itself exactly. Rather it is to warn against any undue focus on one or two or even three months of such data. There is also a warning about Fed policy. If the Fed were to adjust as market participants seem to expect it to, it would show a remarkable ignorance of how these statistics work. If monetary policy makers know their job, and there is evidence that they do, they will take this relief under advisement but otherwise wait for a good deal more confirmation before altering policy directions.

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