Commentaries

PMC Weekly Review -October 16, 2015

A Macro View – Keep Your Eye on the CPI

On Thursday, the Bureau of Labor Statistics* released the September Consumer Price Index, (CPI), a key measure of inflation. CPI fell 0.2% in September, and follows a 0.1% drop in August. It may seem like small change, but when compounded with other months’ movements, it has wide-ranging effects on economic policy decisions, and at a more granular level, on disposable household income. An additional CPI Index, often referred to as Core CPI, excludes energy and food item price changes, and measures the “core” or “underlying” rate of inflation. September Core CPI rose to 0.3%, a marked gain over August’s 0.1% figure.

So, what does CPI actually measure, and why does it matter? It sometimes is referred to as a cost-of-living index, but that’s not entirely accurate. CPI tracks only the changes in prices, not the changes in standard of living. More accurately, the CPI tracks a market basket of consumer goods and services purchased by households. The market basket consists of 200 categories, separated into eight major groups: Food and Beverages, Housing, Apparel, Transportation, Medical Care, Recreation, Education and Communication, and Other Goods and Services. The prices of 80,000 items from these major groups are recorded and weighted based on survey results from households around the country, and then are compiled to form the Index.

Core CPI is a modified measurement that removes the most volatile components, energy and food items, and helps to represent better the persistent changes in price levels. Core CPI was introduced in the early 1970s when food and oil prices were especially volatile, and policy makers needed an index that was less susceptible to short-term shocks. More recently, as oil prices have collapsed, we’ve seen large shocks to energy-related goods, and the need to exclude them from measurement has taken on greater significance. Core CPI has become more meaningful over the past several quarters, as the Federal Reserve (Fed) has targeted a 2% inflation rate before raising its Fed Funds rate. Although the Fed relies primarily on the less-volatile Personal Consumption Expenditures (PCE), Core CPI is a secondary measurement, and it serves as an accurate measure of medium-term inflation.

The September figures signal not only a divergence between CPI and Core CPI, but also zero to negative CPI price movements over the past several months. Since Core CPI strips out energy and food items, they are the two major culprits in the divergence. This is particularly true for energy items: oil prices have fallen in the past few years, in the wake of high supply levels and weakened demand based on global economic malaise. The drop in regular CPI, the largest in the last eight months, would be of greater concern if it weren’t derived primarily from lower energy prices.

Another point to consider is the dollar’s recent strength relative to nearly every major currency, which suppresses inflation and, therefore, CPI. The drop in CPI would be more unsettling, however, if Core CPI figures were to reverse course and begin to fall over the next several quarters. In the U.S.’s consumer-driven economy, falling Core CPI figures would signal deflation, and, in turn, could influence consumers to save rather than spend—a blow to our somewhat fragile economic recovery.

We’re now on track to miss the Fed’s proposed 2% target. But pay attention to the next several months’ results for both CPI and Core CPI, and how policymakers and the economy react.

* The Bureau of Labor Statistics (BLS) is a unit of the United States Department of Labor. It is the principal fact-­‐finding agency for the U.S. government in the broad field of labor economics and statistics and serves as a principal agency of the U.S. Federal Statistical System.

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