June 6th, 2011
Econintersect: Is the recent bout of price inflation good news as it is defeating deflationary forces? If it is, a recent Federal Reserve study says this is a healthy transition to normal pricing patterns.
On the other hand, the fact that the traditionally more stable components of inflation, such as rents, are the ones driving its increase could continue to drive overall inflation higher in the months to come. Follow up:
Econintersect remains focused on inflation, as inflation contaminates economic models. The exact tipping points where inflation becomes a major headwind is distilled to guesses. The study included an inflation "heat" map - the warmer the color, the larger the inflation.
The heat map prompts several interesting observations in the analysis.
First, most of the bars are yellow or orange. This is true by count, but even more so by relative importance, as shown in the key. Two-thirds of expenditures by 2010 relative weights are in the orange category and 18 percent are in the yellow one. Summing these two, we see that 84 percent of all expenditures in the CPI basket were on items that experienced above-average increases in inflation in the last seven months. No bar is red, however, which would indicate inflation increases of more than 2 standard deviations above the mean. This suggests that the recent pickup in inflation is indeed quite widespread across a broad swath of CPI goods and services, but no one item has registered inflation increases that are clearly outside the norm of the last decade, not even among the volatile food and energy categories. In fact, the noncore items, indicated in green, do not show the largest standardized inflation increases, but they are closer to the middle of the pack, with higher increases in food than in energy.
Second, except for household furnishings, the items with the most notable standardized increases are rent and owners’ equivalent rent, which is a measure of the opportunity cost for homeowners of living in their own house. Ordinarily, the inflation rates of these two items are among the most stable components of the CPI. Following the housing bust, however, rent inflation fell from above 4 percent in 2007 all the way into negative territory in mid-2010. Both rent price indexes have recovered quite briskly from these historical lows in the past year, in conjunction with the improvement in the economy.
Econintersect will continue to monitor inflation, and as long as it remains an economic danger - will continue to headline analysis of data.