Inflation Is Definitely Not a Problem

There are many things you might want to worry about concerning the U.S. economy, but inflation is definitely not one of them.  We continue to get nothing but good news on that front.

There are two primary measures of inflation in the U.S.  The one that people are most familiar with is the Consumer Price Index (CPI).  It is based on the prices of a basket of goods using fixed weights and is calculated and reported every month by the Bureau of Labor Statistics.  BLS reported the data for October 2013 on November 20.

Chart 1 shows the pattern for the overall CPI since 1946.


Chart 1

The base for this index is 1982-1984=100.  The index in October was 233.5.  This is the index for all urban consumers, the CPI-U.  BLS also publishes a CPI for urban wage and clerical workers, the CPI-W.

There is also the chained CPI index for all urban consumers (C-CPI-U).  That’s the one that has generated lots of discussion in Washington, D.C. as a candidate to replace the CPI-U in calculating the annual cost of living increase for Social Security benefits and income tax brackets.  If those changes happen, many more people will become familiar with this index. The C-CPI-U uses weights that change as consumption patterns change. That’s why it rises less than the CPI-U.

Chart 2 shows the year-over-year percentage changes in the CPI-U.  You can clearly see the big increases in prices after price controls expired after World War II and during the Korean War.  You can also see the period of the “Great Inflation” of 1965-1980 followed by the “Great Moderation.”


Chart 2

The CPI-U only rose by 1.0 percent in the twelve months ending in October 2013.  That’s mostly because energy prices fell by 4.8 percent, led by a 10.1 percent drop in gasoline prices.

The CPI-U excluding food and energy is called the “core CPI-U.”  It rose 1.7 percent in the year ended in October.

Either way suggests there is not much inflation in the system.  The members of the Federal Open Market Committee prefer to follow the implicit price deflator for personal consumption expenditures.  That’s because it both uses changing weights and measures all goods and services that consumers use. This measure is computed by the Bureau of Economic Analysis and is reported in the quarterly national income and product accounts.  The most recent data came out on November 7, 2013.

Chart 3 shows this measure. Its base is 2009=100.  This index was up only 1.1 percent from the third quarter of 2012 to the third quarter of 2013.  The index excluding food and energy was up only 1.2 percent for the same period.


      Chart 3

The raw material for inflation is the rate of growth of the broad M2 money supply.  This includes currency, demand deposits, savings deposits and time deposits of $100,000 or less.  The late Milton Friedman, recipient of the 1976 Nobel Memorial Prize in Economic Science, devoted much of his life to the study of money growth and inflation.  He taught all of us that “Inflation is always and everywhere a monetary phenomenon.”

The Board of Governors of the Federal Reserve System reports these data every week in its “Money Stock Measures-H.6” release. For the 52 weeks ended November 11, 2013, the rate of increase in M2 has been 6.5 percent.  That’s in line with the past three years and is no reason for alarm.

If you want to worry about the U.S. economy, then worry about how to break the U.S. economy out of the slow growth we’ve been experiencing since the recession ended in June 2009.  This has been the weakest expansion after a recession in over 100 years.  We are now in the fifth year of the expansion and real GDP is only 10.0 percent above where it was at the trough in the second quarter of 2009.

Dr. James F. Smith
Chief Economist