'Inflation' Is Not Just One Thing

Worries about inflation have been at the heart of recent market ructions. The Federal Open Market Committee's January minutes, released on Feb. 21, hardly sounded an alarm that inflation was about to go on a tear, but the FOMC did cite the "risk that inflation could increase more than expected." 

Since rising prices have become such a bugaboo, it's worth digging into what inflation really means. First of all, there are two broad types of inflation: "headline," which includes a wide range of goods and services, and "core," which leaves out food and fuel in order to reduce month-to-month volatility in the index. What index is that? There are two main ones: the consumer price index (CPI), reported by the Bureau of Labor Statistics and the personal consumption expenditures (PCE) reported by the Bureau of Economic Analysis. The Fed prefers PCE – hold the food and fuel. The media tend to favor the CPI.

There are a number of differences between the PCE and CPI, but most of their divergence – the CPI rises about half a percentage point faster per year than the PCE – comes down to the basket of goods and services used to measure them.

Making these baskets is an attempt to crunch all of the typical consumer's typical expenditures into a single number, representing the overall price level of the economy (except for asset prices), so that its change over time can be measured. This is, of course, a necessary exercise. Fed rate-setters would be lost without such an overall measure of inflation, and government statisticians bring a great deal of rigor to bear on the issue.

But how can a single number capture the price of transportation, medical care, fuel, utilities, apparel, food, drink, fun, tuition, gadgetry and housing? What does it look like if we break them out?

The chart above shows the change in select components of the CPI since the end of the 2001 recession. The index as a whole rose 40.4% from November 2001 to January 2018, very close to the rise in the transportation (40.1%), food and beverages (43.6%), and housing (43.7%) components.

The education and communication component, on the other hand, has only risen 28.3%. This is surprising in an era of surging tuition, extortionate textbook prices and $1,000 iPhones, all of which fall under that component. These factors are tempered by falling telephone services costs (-8.7% since November 2001), a factor which receives considerably higher weighting (2.332) than college tuition (1.613) and textbooks (0.132) – not to mention the fact that student loan interest doesn't feature in the calculation.

Meanwhile overall CPI is dragged higher by rising fuels and utilities prices (66.1%) and especially the healthcare juggernaut (73.6%).

It's not all bad news for consumers, though. Apparel is actually cheaper than it was in 2001.

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