Watch Out for Surge in CPI

by Philip Brewer on 16 July 2009 6 comments
Photo: foofoo_five

Just to be clear, I'm also worried about a surge in inflation, but that's not what I'm talking about here. I don't know the future, so I try to stay away from predictions. But you don't need to know the future to "predict" a surge in the Consumer Price Index. All you need is to know the recent past.

I distinguish between inflation and the CPI. Inflation is the money becoming less valuable. The Consumer Price Index is an indicator of recent prices based on the prices of a standard basket of consumer goods.

The CPI is just a number. The number for June (reported July 15th) was 215.693 (versus a base of 100 in 1983).

Most people, though, don't really care about the number--they care about changes. And that makes sense--rising CPI values are an indication of rising prices, and rising prices are an indication of inflation.

(As an aside, rising prices don't necessarily mean inflation. Lots of things, such as changes in styles, tastes, and consumer preferences can change relative prices. Some things, such as taxes, technological change, and resource depletion, can change absolute prices. But none of those things are inflation, even if they result in rising prices.)

Almost all the attention to the CPI focuses on two things:

  • The change from last month
  • The change from last year

And it's that second one that prompts me to warn of a surging CPI.

After peaking in July last year, energy prices fell for months. From July 2008 to March of 2009, energy prices fell 37%. (Data from Bureau of Labor Statistics.) Energy prices amount to about 7.5% of the index, so that fall, all by itself, has had the effect of subtracting something like 3 percentage points from the overall CPI change from a year ago.

The thing is, most of the recent fall occurred in the last three months of last year. In the CPI index values published in the coming November, December and January, those big declines will "drop off" the year-ago comparisons--which will produce the surge I'm talking about. The "change from a year ago" values reported for the CPI for those months is going to be much higher--pretty much regardless whether there's any inflation.

Does it matter? Well, it matters to some people--people who invest in TIPS, for example, care a lot about the reported value of the CPI. (People on Social Security also care a lot, but as it happens the base year for figuring Social Security cost of living adjustments ends in September, so the effect of this spike won't show up until 2011.)

In fact, though, what really matters to real people is how their own cost of living changes.

I just wrote a post making fun of another economist's prediction of inflation, so I want to be really clear about the distinction here: What I'm talking about is a statistical artifact of the way the CPI gets calculated. For the past year, falling energy prices have made the inflation numbers look artificially low. For the next few months, CPI calculations of "changes from a year ago" is going to show inflation numbers that are artificially high--even if the value of the money were stable, we'd still see a spike in the CPI simply because the base month for comparison is going to have lower and lower fuel prices.

Last October I wrote a post called Inflation is going away for a while. Despite my general reticence about making predictions, things seemed clear enough to risk that one. This post is my official announcement that "a while" is just about over.

With that in mind, I'll direct you to a post of mine from earlier last year: How to live with inflation. Everything old is new again.
 

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Guest's picture

Philip--You aren't just barking at the moon here. All of the money being funnelled into the banks will hit the streets sooner or later, and when it does, price directions will change, probably pretty quickly too.

Prices of some things are falling because we're learning to do with out them--mostly luxuries. But for things we need or can't do without, like healthcare/health insurance, education, utilities and car repairs, inflation is here now. That's probably the tip of the iceberg, and a sign of things to come.

While things are relatively quiet, now is a good time to cut living expenses, increase savings, and find new ways to earn extra income. If inflation doesn't hit, you'll be richer for having done all of the above.

Guest's picture
Guest

I don't think we are headed into a big inflationary period at all. Until this current economic condition works itself out, and that will be years, the Fed is going to keep a lid on interest rates. And when the time comes to raise we are looking at small increases as to no derail the recovery, especially the housing markets rebound which will partly be affected by mortgage rates.

Skyrocketing broad based inflation and low, low interest rates just don't occur simultaneously.

Will prices in some areas continue higher? Sure. But I don't think we are anywhere close to entering a significant inflationary environment.

Guest's picture

Philip my friend I wish I could agree with you in the short term. The problem is the recent CPI numbers have been held up by energy prices and healthcare. If you remove those factors we're in the middle of some serious deflation.
http://www.businessinsider.com/henry-blodget-whos-bankrupting-you-these-...

Philip Brewer's picture

We don't know how much new inflation we'll have over the next few months, but we don't need any new inflation to get the surge I was talking about.

Here's a chart that probably should have been in the main body of the post.  Suppose prices remain exactly where they are now for the next few months.  Here's what happens to year-over-year reported change in CPI under that scenario:

  • August -1.94%
  • September -1.46%
  • October -1.43%
  • November -0.47%
  • December 1.24%
  • January 1.99%

You see the reported change in inflation swings from a deflation rate of nearly 2% to an inflation rate of nearly 2%, even if there's no change in prices at all--simply because the base month for the year-over-year changes.

Change in the CPI has not, in fact, been running at zero, though.  For the past six months, it's been running at 2.7%.  If that continues for the next six months, we'd have to add that on.  So, just continuing on our recent path would bring the annual change in the CPI to 4.7% by the beginning of next year.

Now, 4.7% inflation is not the worst rate ever, but it's a pretty big jump from negative 2%.  More to the point, it's not a prediction based on recent changes in the money supply causing a surge in prices--it's just a calculation based on the numbers that are already out there.  If we get a surge in prices too, it would be layered on top of this.

So, keep an eye on the reported CPI number, and be aware that changes of this magnituted are already "baked in."

That's what I was trying to say.

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PREDICTIONS

Old Chinese proverb.People who live by the crystal ball wind up eating glass.

Guest's picture
Kelja

The CPI has always been a suspect number because the government has tweaked it so many times since its inception. Be that as it may, I think the number will start an inexorable rise in the not so distant future. The government won't be able to hide it.

Why?

The present administration has never found a problem that throwing money at won't solve (in their opinion anyway). Hey, his chief of staff, Ralm, said, 'never let a good crisis go to waste'. Do you think possibly they might be tempted to even create some?

The level of out-of-control, budget-busting spending takes one breath away. I know, politicians always overspend and every administration before Obama has been guilty of the same thing. But the scale of what's going on right now has to scare you silly. If it doesn't, well, you're just ingesting too much kool-aid.

But we live in a world where the people are sheep, so I don't expect any uprising or change of course until the whole thing come tumbling down.