Financial markets reacted gleefully to the Labor Department’s October consumer price index (CPI) release. It shows an extension of the modest relief from the terrifying figures of last spring.
Investors seemed to think that inflation pressures were dissipating and that perhaps the Federal Reserve might ease up on raising interest rates and on its other counter-inflationary policies. The Dow Jones industrial stock index rallied by about 1,200 points in a single trading session. If such thinking really stood behind the rally, then investors will likely face disappointment. The fact is that inflationary pressures, such as the nation has faced for more than a year now, don’t dissipate quite so quickly.
One such source of perspective lies in the October report’s detail. It made clear that inflationary pressure remains widespread. Food prices rose by 0.6 percent in October, a slight moderation from earlier months but still a 7.5 percent annual rate of increase and hardly a point of comfort for America’s homeowners. Moreover, the price of shelter overall—both ownership and rentals—rose at a 10 percent annual rate, an acceleration from prior months. Because these two items alone constitute more than 46 percent of the average American’s household budget, the feeling of relief can only be described as stretching it.
The so-called core inflation measure—all items excluding food and energy—did moderate to a 3.7 percent annual rate of increase, but that was due almost entirely to one item: a tremendous 2.4 percent monthly drop in the price of used cars and trucks. If that pattern promised to last, the news might be significant, but with the price of new vehicles still rising at a 7.5 percent annual rate, it’s hard to see the price of used vehicles falling for very much longer.
Another reason to curb enthusiasm emerges from a review of how inflation measures behave over time. History makes clear that the variation in inflation measures month-to-month rises when inflation, on average, is high. Take the period of the last great inflation between 1973 and 1981. The record of rolling 12-month inflation measures during that terrible time shows a high measure of 14.6 percent (in March 1980) and a low of 5 percent (in December 1976), with the measures bouncing between these bounds throughout that time. That is a 9.6-percentage-point difference.
By contrast, during the low inflation period of similar duration at the beginning of this century, the high inflation was 3.6 percent (in November 2004), and the low was a deflation of 2 percent (in July 2009). That’s a difference of 5.6 percentage points, barely more than half the difference seen in the earlier high-inflation period.
A still stronger warning against making too much out of one month’s report is how the inflation measures always bounce around from month to month. Take 2003 for example, a year when the average came in right on the Fed’s preferred 2 percent annual rate. The year began with a 0.5 percent CPI jump in January, a 6.1 percent annual rate of advance. A focus on that month’s data might have caused concern. In April and May, however, the department reported monthly CPI declines of 0.3 percent on average. Too close a focus on those figures might have raised fears of outright deflation. Since the year came in right on target, either focus and the attendant fears it brought would’ve been dangerously misplaced, either for policymakers, investors, or citizens.
None of this is to ignore recent figures. Instead, it’s to warn against any undue focus on one or two or even three months of such data. There’s also a warning about Fed policy. If the Fed were to adjust, as market participants seem to expect it to, it would show a remarkable ignorance of how these statistics work. If monetary policymakers know their job, and there’s evidence that they do, they'll take this relief under advisement but otherwise wait for a good deal more confirmation before altering policy.
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