Ed Dolan's Econ Blog

CPI Closes Out a Quiet Year for Inflation with a Little Bounce

The Bureau of Labor Statistics reported yesterday that the U.S. consumer price index closed out an otherwise quiet year with a small bounce in the rate of inflation. The all-items CPI increased at a seasonally adjusted annual rate of 3.62 percent for the month of December. The uptick was largely due to an increase in energy prices, which rose by a seasonally adjusted 2.1 percent in the month. The closely watched but highly volatile gasoline component rose by 3.1 percent. Prices for all energy and for gasoline had decreased in November. The core CPI, which tracks all items except food and energy, increased at an annual rate of just 1.31 percent in December.

As the following chart shows, when month-to-month volatility is removed, the trend for both the all-items and core CPI has been toward slower inflation over the past two years. Both the all-items and core CPI are now tracking well below the Fed’s inflation target of 2 percent.

The above chart shows seasonally adjusted data. Since the seasonal adjustment process is subject to error, economists also like to watch year-on-year changes in price indexes, which are free from problems of seasonal adjustment. The change in the all-items CPI from December 2012 to December 2013 was 1.5 percent, and the change in the core CPI over the same period was 1.7 percent. For the year from December 2011 to December 2012, the increases were 1.6 percent for the all-items CPI and 1.9 percent for the core. These figures confirm the continued moderation of inflation.

In addition to the BLS data on current inflation, the Cleveland Fed publishes an estimate of expected future inflation, based on an analysis of the prices of Treasury Inflation Protected Securities (TIPS). The idea behind these estimates is that if investors expect inflation to increase in the future, they will pay more for the inflation protection offered by TIPS compared to the price they will pay for ordinary, unprotected Treasury securities. As the following chart shows, inflation expectations over five- and ten-year time horizons increased in the second half of 2013 after having been flat for the previous two years.

Despite the recent increase, inflation expectations, like the trends for the all-items and core CPI, remain well below the Fed’s 2 percent target. The recent increase in inflation expectations no doubt reflects stronger data for jobs and GDP growth in the second half of 2013. Those signs of a strengthening recovery have led the Fed to begin to taper its expansionary policy of quantitative easing.

On the whole, both current rates of inflation and forward-looking estimates based on the expectations of investors suggest confidence that the Fed, under its new leadership, is unlikely to allow the recovery to strengthen into an inflationary boom. If anything, the data may suggest to some that the Fed is being excessively cautious and that the taper is premature.

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