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What Is Really Pushing Inflation Higher?

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After the financial crisis and subsequent recession in 2008, inflation has been a stubborn thorn in the side of the Federal Reserve (Fed).  In 2011 and 2012, inflation rose well above 2 percent, reaching as high as 3.8 percent in September 2011, as prices rebounded after the crisis.  (The Fed officially established a target inflation rate in January 2012.)  As we know, the Fed never raised rates in 2011 or 2012 amid pressures to do so.  The Chairman of the Federal Reserve Board, Ben Bernanke, consistently defended the notion that inflation was rising primarily due to higher commodity prices, which were transitory.  Inflation today is steadily rising, hitting 2.89 percent in July 2018, but does it stem from transitory effects like it did in 2011?  We looked at the data to find out.

Consumer price index (CPI) inflation

The most notable category within CPI inflation is housing, as it makes up over 40 percent of the total index.  Housing includes prices for shelter, appliances, utilities, and household furnishings (among others).  However, this category has stayed relatively constant over the past year, contributing around 1.20 percentage points and doesn’t provide any indication that prices within the housing sector have provided a significant boost to rising inflation.

One subtle difference in the exhibit above is in the education and communication category.  As we wrote in an earlier piece, throughout 2017 wireless telephone service prices fell drastically due to increased competition among cell phone companies, subtracting from aggregate inflation throughout 2017.  The education and communication category is no longer a drag.  Instead, it is currently contributing a small amount to aggregate inflation.

What stands out in the table is the rise in contribution from the transportation category.  Transportation takes consumer prices of automobiles, auto parts and services, as well as motor fuel.  Over the past couple of years, the transportation category has clearly impacted headline CPI inflation.  As the transportation category’s contribution reduced, inflation slowed, and the reverse has occurred over the past year.

The following table shows how the various components of inflation changed over the past year.  As we discussed above, the transportation category was the largest driver of higher inflation, accounting for 85 percent of the increase.  This was followed by the education and communication category, which improved based on reasons we stated above.  The remaining six categories were more or less steady.

Related: Why the Rising Trade Deficit May Not Be So Bad

What is driving transportation inflation higher?

As the transportation category has played an integral part in rising inflation, we wondered what sub-component was driving the category and aggregate inflation higher.  Intuitively, we wanted to look at motor fuel as it makes up nearly 24 percent of the transportation category, and gasoline prices have been much higher this summer than last year.

The table below shows the contribution of motor fuel to the transportation category.  In July 2018, motor fuel contributed 0.99 percentage points – close to 85 percent of the transportation category’s 1.16 percentage point contribution to inflation.

The other transportation sub-components contributed only 0.17 percentage points.  However, in July 2017, both motor fuel and remaining transportation sub-components contributed about the same to transportation, when the category made up 0.18 percentage points to overall inflation.  In other words, motor fuel contribution increased 0.89 percentage points, while the rest of the transportation sub-components increased only 0.08 percentage points from a year ago.  This corresponds to motor fuel making up approximately 91 percent of transportation’s increase.

Inflation excluding motor fuel

If we exclude motor fuel from all items, we see a very different picture of CPI inflation.  In July 2018, headline inflation came in at 2.89 percent, while (from our calculation) inflation excluding motor fuel came in at 1.89 percent.  From a year ago, inflation increased 1.15 percentage points, while inflation excluding motor fuel increased only 0.25 percentage points.  Put in a slightly different way – motor fuel – accounted for 78 percent of inflation’s rise over the 12-month period.

What is evident from the data is that the price of commodities like motor fuel, i.e. gasoline, can fluctuate drastically over the course of several months and should be carefully considered when analyzing inflation.  Already, we are seeing the price of oil come down from its peak of nearly $73 per barrel in July, and crude oil futures indicate that prices will continue to fall to the lower $60s in the fall and winter.  As a result, motor fuel prices will also fall.  Therefore, our view is that motor fuel has a transitory effect on aggregate consumer prices, and if other, more stable core prices fail to rise, there will likely be a slowdown in aggregate inflation as we end 2018.

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