March 2012 CPI Continues to Moderate

by Steven Hansen and Doug Short

The March 2012 Consumer Price Index (CPI-U) annual inflation rate declined from 2.9% to 2.7%. Core inflation (CPI less food and energy) again rose slightly from 2.2% to 2.3% annual inflation [note that the Federal Reserve uses 2.0% core inflation as an inflation target].

There has been some hinting at the Fed that inflationary targets may be flexible at this time with so much economic slack, and the Fed statements continue to indicate they expect inflation to recede in the coming months.

The real question is why inflation is moderating at this point in an economic cycle.  Inflation generally accelerates as the economy heats up – and a lower inflation rate could be an indicator that the economy is cooling.  However, because of globalization and free trade – it is hard to be sure how this relates to the economy.

First, the major inflation issue in month-over-month CPI from remains crude oil products and in new and used cars.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in March on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 2.7 percent before seasonal adjustment.

The indexes for food, energy, and all items less food and energy all increased in March. The gasoline index continued to rise, more than offsetting a decline in the household energy index and leading to a 0.9 percent increase in the energy index. The food index rose 0.2 percent as the index for meats, poultry, fish, and eggs increased notably.

The index for all items less food and energy rose 0.2 percent in March after increasing 0.1 percent in February. Most of the major components increased in March, with the indexes for shelter and used cars and trucks accounting for about half the total increase for all items less food and energy. The indexes for medical care, apparel, recreation, new vehicles, and airline fares increased as well, while the indexes for tobacco and household furnishings and operations were among the few to decline in March.

The all items index has risen 2.7 percent over the last 12 months, a decline from last month’s 2.9 percent figure. The energy index has risen 4.6 percent and the food index has increased 3.3 percent; both increases are smaller than last month. In contrast, the 12-month change in the index for all items less food and energy, which was 2.2 percent last month, edged up to 2.3 percent in March.

Yesterday, the Producer Price Index for finished goods (analysis here) year-over-year increase declined from 3.3% to 2.8% – which Econintersect calculated to be indicative of a CPI around 2.0%. Essentially, the inflation rates in finished goods and at consumer level are the same (no upward pressures on inflation from the supply chain).

On the other hand, historically, the CPI-U general index tends to correlate over time with the CPI-U’s food index. This puts an upward pressure on the CPI. These forces are in conflict. (chart below to be changed out when FRED updates).

Notice the gap in the above graphic between the CPI and Food – historically this gap has always closed as the knock-on effect from higher food prices (as well as higher energy prices) causes higher prices throughout all CPI components.

The market expected month-over-month CPI-U growth at 0.3% to 0.5% (versus 0.3% actual), with the core inflation expectations at 0.2% (versus 0.2% actual).

The Federal Reserve has argued that energy inflation automatically slows the economy without having to intervene with its monetary policy tools. This is the primary reason the Fed wants to exclude energy from analysis of consumer price increases (the inflation rate).

Detailed Analysis

The Bureau of Labor Statistics released the CPI data for last month this morning. Year-over-year Headline CPI came in at 2.65%, which the BLS rounds to 2.7%, down fractionally from 2.87% last month. Year-over year-Core CPI came in at 2.26%, which the BLS rounds to 2.3%, up from 2.18% last month.

The first chart is an overlay of Headline CPI and Core CPI (the latter excludes Food and Energy) since 1957. The second chart gives a close-up of the two since 2000.

On this chart, we’ve highlighted the 2% level, which is generally understood to be the Fed’s target for core inflation. Here we see more easily see the widening spread between headline and core CPI since late 2010, a pattern that began changing last October as headline inflation declined while core has continued to rise.

Federal Reserve policy, which focuses on core inflation, and especially the core Personal Consumption Expenditures (PCE), will see that the latest core CPI is fractionally above the target range.

Caveats on the Use of the Consumer Price Index

Econintersect has performed several tests on this series and finds it fairly representative of price changes (inflation). However, the headline rate is an average – and will not correspond to the price changes seen by any specific person or on a particular subject.

Although the CPI represents the costs of some mythical person. Each of us need to provide a multiplier to the BLS numbers to make this index representative of our individual situation. This mythical person envisioned spending pattern would be approximately: Food (15%),

  • Housing (42%),
  • Clothing (4%),
  • Transport (17%),
  • Medical (6%),
  • Pocket Money (6%),
  • Education (6%), and
  • Miscellaneous (4%).

The average Joe Sixpack budgets to spend his entire paycheck or retirement income – so even small changes have large impact to a budget.

The graph above demonstrates that fuel costs, medical care, and school costs are increasing at a much faster pace than the headline CPI-U – while housing and food costs generally mimic the headline CPI-U.

The Consumer Price Index contains hundreds of sub-indices which should be used to show price changes for a particular subject.

Because of the nuances in determining the month-over-month index values, the year-over-year or annual change in the Consumer Price Index is preferred for comparisons.

Econintersect has analyzed both food and energy showing that food moves synchronously with core. Remember 36% of the CPI is housing based (41% including energy) with 17% food and about 10% of the index is energy related.

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