Ed Dolan's Econ Blog

How Concerned Should We Be About June’s Sharp Jump in Inflation?

U.S. consumer price inflation jumped to a seasonally adjusted annual rate of over 5.9 percent in June, according data released today by the Bureau of Labor Statistics. That was up from an inflation rate of just 1.8 percent in May. In March and April, the CPI actually decreased. How much do we need to worry about the sharp increase in inflation, or the increasing volatility of inflation over the past year, both of which are evident in the following chart? Here are some points to consider.

First, the jump in the monthly inflation rate and the volatility of recent months are almost completely due to ups and downs in the seasonally adjusted price of gasoline. It rose 6.1 percent in the month of June alone after no change in May and decreases of 8.1 percent in April and 4.4 percent in March (all monthly changes, not annualized). The price of gasoline is notoriously volatile. It depends not only on world oil prices, but also on the dynamics of domestic refining and on driving habits.

Other energy and food prices are also volatile, although not quite so much so. If we strip food and energy out of the CPI, we get the seasonally adjusted core CPI, which varies much less from month to month, as the next chart shows.

Second, the price of gasoline really did not increase much in June. The reported seasonally adjusted price rise for June was 6.3 percent, but in reality, the price at the pump went up by only 0.6 percent. Seasonal adjustments depend on what usually happens to the price of a good in a given month. Usually, the price of gasoline rises in the spring, with the rate of increase peaking in May. The price then usually falls a bit in June. This year, for some reason, the usual June decrease in the unadjusted gasoline price did not occur. Instead, the seasonal adjustment factor made the failure of gasoline prices to fall look like a sharp increase. Gasoline has a large weight in the CPI, accounting for 5.6 of all consumer expenditures, so the misdirected seasonal adjustment skewed the whole CPI upward.

As we see in the following graph, the seasonally adjusted CPI is usually less volatile than the nonadjusted version—that is the whole reason for seasonal adjustment in the first place. However, in June, the rise in the adjusted version was considerably more than that of its unadjusted counterpart.

We can filter out both the volatility of monthly data and the quirks of the seasonal adjustment process by looking at year-on-year changes in the CPI. The following chart shows changes in both the all-items and core CPI for each month relative to the same month of the previous year. As the chart shows, inflation by both measures has been trending downward over the past couple of years. Both are now well below the Fed’s announced 2 percent inflation target.

All things considered, then, there appears to be no objective reason for policymakers to worry about the anomalous jump in seasonally adjusted monthly CPI inflation for June. If anything, the Fed should be worrying that its policy is too tight and that it is holding inflation below its appropriate level.

That does not mean, though, that consumers will stop complaining about inflation. Consumers put very different subjective weights on price changes than those applied by the BLS. Consumers pay more attention to the prices of things that they buy frequently, like milk and gasoline, than on things they buy less often, like appliances or computer software. Furthermore, as behavioral economists remind us, they perceive losses from the increased prices of some goods more sharply than equivalent gains from decreased prices of other goods. As a result, for many if not most people, the perceived rate of inflation exceeds the measured rate of inflation. If you are among the many who think that inflation is still an imminent threat to our economy, I welcome your comments.


6 Responses to “How Concerned Should We Be About June’s Sharp Jump in Inflation?”

windrivenJuly 17th, 2013 at 10:40 am

"That does not mean, though, that consumers will stop complaining about inflation."

The perceptions of inflation for average middle class consumers are shaped by purchasing power rather than by the vagaries of seasonal adjustments and weightings of market basket components. Job creation is sluggish and many jobs are relatively low-paying and often part time. It doesn't matter to the consumer what the CPI comes in at when the hours worked don't purchase as much as they did, say, five years ago.

Kevin RocheJuly 18th, 2013 at 9:10 am

I think what affects consumers is the actual spending they have to incur each pay period. For the really average person, gasoline and food are a significant percent of their total spending. Increases in the cost of those are real. For those of us who write this blog or comment on it, they matter less because of our likely income. The more useful statistics are those showing for various income groups, how much of their spending has to go to various categories, and what are those changes over time. Considering that the income of the lower and middle income groupings has changed little for years, any increases in prices of items they commonly buy is meaningful.

kakatoaJuly 20th, 2013 at 12:03 pm

Ed, __I am not sure how the costs for potable water and sewer service are tracked, but I have been watching how a few local water districts in my area are working though their increased costs to provide these core services- _ _ water district noted above were early adaptors as far as sewage treatment goes. Their competitive disadvantage vs. neighboring counties/cities has recently improved as the mandates that they had to meet years ago have now been required (and met) by one of the adjoining counties/cities water district. The next water district that is going to be mandated to meet the mandates will be Sacramento so their current competitive advantage will be coming down as they allocate the increased costs to provide tertiary sewage treatment at all their facilities. __It does seem rather amazing that EID's charge for a 3/4" potable water meter hook up have gone up 156+% (from $7800 to just over 20K) over the last half a dozen years. The water rates have gone up (about 40% from 2009 to 2012) and will be going up some in the future as well- "Water rate hikes add up to a 37 percent increase between 2012 and 2015." _

PeterCJuly 23rd, 2013 at 6:38 am

The inflation rate faced by the average person, or the person median in the income distribution is not the same as the inflation rate reflected in the CPI, for a couple of reasons. First, CPI is based on the average of expenditure patterns for everyone, and hence is more heavily biased to reflect the expenditure patterns of those significantly better off than the poor or those on median incomes, and as the things that have gone down in price are the things where expenditure is more discretionary, electronic goods and so on, and those things that have gone up more in price are the essential, so-called inferior goods, that everyone buys proportionately less of as they become better off, the inflation rate faced by a rich person is significantly less than the inflation rate faced by a poor person. (Yes. That everyone faces the same inflation rate is a nonsense, because expenditure patterns are not identical, so the weights on inflation indexes created for different individuals would not be the same.) The second reason is that, especially since the Boskin commission, there have been increasing changes to the way the CPI is calculated which have, in the view of some at least, disguised the actual rate of CPI increases. The problems in creating a satisfactory CPI index are non-trivial, and it may even be that constructing such an index is not possible. On top of this is that increasingly politics has come into it, The Boskin commission was created with the aim of reducing reported CPI changes as a way of decreasing social security payments and fix the budget during the Clinton years. To do that the commission was peopled with economists who were on record as believing that the CPI overstated inflation. There were also economists that believed the opposite and naturally they were not included and their views were ignored.

Ed Dolan EdDolanJuly 23rd, 2013 at 10:11 am

Your hypothesis that prices of goods used by middle and lower income groups goes up faster is interesting. Do you have a source on it? I have often seen the opposite hypothesis–that prices of 'positional goods' (high fashion items, unique items like artwork, luxury items like yachts) go up faster than mass produced goods as inequality increases.