Let’s Not Ignore Economic Optimism
According to data released this week by the U.S. Bureau of Labor Statistics, the U.S. Consumer Price Index fell in April at an annual rate of -4.35 percent. It was the second consecutive monthly decrease and the fastest rate of decrease since late 2008, when the economy was in free fall.
The April decrease was largely attributable to lower gasoline prices, as have been almost all of the gyrations in the index since the start of the year. The core CPI, which removes its food and energy components, shows much less month-to-month volatility. It rose at an annual rate of 0.6 percent in April, its slowest rate of increase since 2010. The following chart shows that both all-items and core inflation have trended gradually downward over the past two years.
Many people are skeptical of the CPI data published by the BLS. For various reasons, they believe that the true cost of living is rising much faster than the CPI. Given that perceived inflation is generally higher than the CPI indicates, it will come as a surprise to learn that some professional economists think the CPI overstates the rate of inflation, and does so by an increasingly wide margin.
One piece of evidence pointing in that direction is a growing gap between the CPI, calculated by the BLS on the basis of monthly price surveys, and the price index for personal consumption expenditures (PCE index) that is derived from the national income accounts. There are theoretical reasons for thinking that inflation as measured by the CPI, which uses base-period quantity weights, is likely to average a bit higher than the PCE index. (I discussed some of those reasons in this recent post.) The surprising thing, however, is that the gap between the two indexes has been increasing lately, as shown in this figure reproduced from the Atlanta Fed’s Macroblog. (I have added the CPI for April to the original chart.)
Economists Mike Bryan, Pat Higgins, Brent Meyer, and Nicholas Parker of the Atlanta Fed undertook some statistical analysis to see if the increasing gap between the two indexes is real, or just an artifact of the data. Their conclusion is that there really is a gap, although perhaps the underlying gap is not quite as wide as that shown in the above chart.
As they suggest, the possibility that the CPI is overstating inflation can be viewed as a glass that is either half-full or one that is half-empty. Pessimists may take a very low rate of PCE inflation as a sign that the Fed is failing in its efforts to meet its price stability mandate, which it defines as a 2 percent inflation rate for the PCE. Personally, I prefer to take a more optimistic view.
Right now the economy is making at least gradual progress back toward full employment, at a time when Europe and Japan are struggling with much worse problems and emerging market growth is slowing. It would be a shame to see that progress derailed by a burst of inflation that frightened policy makers into tightening while the recovery remains so fragile. None of the inflation indicators we are seeing right now suggest any such risk.
Don’t Miss Ed Dolan’s “Quantitative Easing: Your Ultimate Cheat Sheet to the Monetary Policy“.