August 13, 2019

The CPI rose 0.3% in July after having risen 0.1% in both May and June..  During the past year the CPI has risen 1.8%.

Food prices rose 0.1% in both June and July.  Food prices have risen 1.8% in the past twelve months.  These prices tend to be lumpy with increases reported for a few months followed by several months of declining prices.

Energy prices rose 1.3% in July after having declined 2.3% in June and having fallen 0.6% in May.  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have fallen 2.0%.

Excluding food and energy the CPI rose 0.3% in both June and July after having climbed 0.1% in each of the previous four months.  Over the past year this core rate of inflation has risen 2.2%, but in the past three months the core rate has risen at a 2.8% pace.  We expect the core CPI will increase 2.4% in 2019 as higher prices on goods imported from China will push this index higher in the months ahead.

The most interesting development in the CPI in recent years has been the dichotomy between the prices of goods (excluding the volatile food and energy components) and services.  For example, in the past year prices for goods have risen 0.2% while prices for services have risen 2.8%.

With respect to goods prices, it appears that the internet has played a big role in reducing the prices of many goods.  Shoppers can instantly check the price of any particular item across a wide array of online and brick and mortar stores.  If merchants do not match the lowest price available, they risk losing the sale.  Thus, they are constantly competing with the lowest price available on the internet.  Looking at specific items in the CPI we find that prices have been unchanged or fallen for almost every major category in the past year.  Apparel prices have declined 0.6%, new cars have risen 0.3%, airfares have risen 1.3%, televisions have declined 20.1%, audio equipment has  fallen 0.5%, toys have fallen 8.8%, information technology commodities (personal computers, software, and telephones) have declined 4.5%.  Prices for all of these items are widely available on the internet and can be used as bargaining chips with traditional brick and mortar retailers.

In sharp contrast prices of most services have risen.  Specifically, prices of services have risen 2.8% in the past year.  The increase in this  broad category has been led by shelter costs which have climbed 3.5%.  This undoubtedly reflects the shortages of both rental properties and homeowner occupied housing. Indeed, the vacancy rate for rental property is at a 30-year low. This steady rise in the cost of shelter  will continue for some time to come and, unlike monthly blips in food or energy, it is unlikely to reverse itself any time soon.

The CPI, both overall and the core rate, will be relatively steady  in the months ahead.  Steadily rising shelter prices, gradually rising labor costs, and higher prices on goods being imported from China will tend to boost the CPI.  But on the flip side, productivity gains are countering all of the increase in labor costs, and the internet is keeping a lid on the prices of goods.  We look for an increase in the core CPI of 2.4% in 2019.

The Fed’s preferred measure of inflation is not the CPI, but rather the personal consumption expenditures deflator, specifically the PCE deflator excluding the volatile food and energy components which is currently expanding at a 1.6% rate.  We expect it to climb 1.9% in 2019.  The Fed has a 2.0% inflation target.

Why the difference between the CPI and the personal consumption expenditures deflator?  The CPI is a pure measure of inflation.  It measures changes in prices of a fixed basket of goods and services each month.

The personal consumption expenditures deflator is a weighted measure of inflation.  If consumers feel less wealthy in some month and decide to purchase inexpensive margarine instead of pricey butter, a weighted measure of inflation will give more weight to the lower priced good and, all other things being unchanged, will actually register a decline in that month.  Thus, what the deflator measures is a combination of both changes in prices and changes in consumer behavior.

As we see it, inflation is a measure of price change (the CPI).  It is not a mixture of price changes and changes in consumer behavior (the PCE deflator).  The core CPI should increase 2.4% in 2019 while the core PCE climbs 1.9%.  That compares to the Fed’s targeted rate of 2.0%.

Given sustained growth in GDP growth this year and the inflation rate being close to target, there is no need for the Fed to alter the level of the funds rate.  However, Fed officials cut rates 0.25% last month and they have indicated a strong intention to drop rates another 0.25% by the end of the year.

Stephen Slifer


Charleston, SC