Wednesday, December 17, 2014

Ex-energy inflation still 2%

The unexpectedly large decline in the November CPI (-0.3% vs. -0.1%) was almost entirely driven by falling oil prices. The CPI ex-energy rose 0.1% for the month and is up 1.9% over the past year.

The chart above shows the year over year change in the CPI and the "core" CPI (ex-food and energy). By these measures inflation has been bouncing around between 1% and 4% over the past decade, and currently looks to be declining a bit on the margin.

Most of the bouncing "noise" in the year over year measure disappears if we remove energy prices from the CPI. The chart above shows the CPI index ex-energy, and it uses a semi-log scale on the y-axis to show that the average annual rate of increase in the index has been 2.0% for the past 12 years. No sign of anything even remotely deflationary here. Once energy prices stabilize, we are likely to discover that CPI inflation is running right around 2% a year, as it has been for a very long time.

The Fed is unlikely to delay its plans to raise short-term interest rates just because the CPI index has declined in two out of the past four months (November and August). Any hint of deflation is entirely oil-related, and therefore not something that should concern the Fed.


Benny Lavva said...


I agree with this. But could low oil prices reduce costs of production of other goods and keep inflation below 2% for a bit longer?


Scott Grannis said...

I think this is what is happening: lower energy prices improve the outlook for growth, and add to the public's general confidence. Improved confidence means less risk aversion, and less risk aversion means less demand for risk-free assets like TIPS and bank savings deposits. That in turn means the velocity of money should pick up, and that will fuel both an increase in real growth and an increase in non-oil inflation.

Put another way, money that is freed up by lower oil prices will likely find its way into the prices of other goods and services.

So the impact on overall inflation of lower oil prices will be minimal.

Benjamin Cole said...

Of course, the Fed says it looks at core PCE, now under 1.5% YOY and sinking. In terms of limiting inflation, this is our most successful Fed ever. If you think the Fed has a single mandate, then Yellen makes Volcker look like a drunken sailor.

In truth, the Fed is doing pretty much what the Bank of Japan did 1992 to 2012 and so expect similar results. Low inflation, low interest rates, slow growth.

Benjamin Cole said...

"The 10-year Japanese government yield is yielding less than 0.35 per cent, down from 0.58 per cent in September."

Question; What did the Bank of Japan do 1992-2012 that the Fed is doing differently today?

So...we will see the same, or similar results?

If the Fed acts like the Bank of Japan, why should we see different results?