February 20, 2008 (Prices Byte)

By Dean Baker

“Higher inflation is the cost of the high dollar policy of the last decade."

The overall consumer price index rose by 0.4 percent for the second straight month in January, pushed up by 0.7 percent increases in both food and energy prices. The January increase brings the annual rate of inflation in the CPI over the last three months to 6.8 percent. Over the last year, prices have risen by 4.3 percent. Core inflation also edged higher at 0.3 percent in January. The core CPI has risen at a 3.1 percent annual rate over the last quarter, up from a 2.5 percent rate for the last year.

Two of the factors pushing inflation higher were 0.4 percent increases in both apparel prices and prices for the “other goods and services” category. Apparel prices have now risen at a 4.6 percent annual rate for the last quarter after having declined consistently for more than a decade. Some of this increase is due to the erratic seasonality of apparel prices and will be reversed in future months. However, much of the increase is due to rising import prices, which are in turn driven by the falling dollar and inflation in China.

The price increase for the other goods and services category was driven primarily by a 1.1 percent rise in tobacco prices. This increase was likely due to taxes put in place at the beginning of the year and is therefore a one-time price rise. Medical care costs continue to be a problem, rising 0.5 percent in January. They have now risen at a 5.1 percent annual rate for the last quarter, up from a 4.9 percent rate for the last year.

On the other side, new car prices fell by 0.3 percent in January and have declined at a 1.1 percent rate over the last three months. While car prices have been trending downward for some time, this pattern may soon be reversed. The import price in index for cars and car parts has started rising more rapidly in recent months, increasing at a 2.4 percent annual rate over the last quarter and a 1.8 percent over the last year. It had risen at just a 0.7 percent annual rate from 2000 to 2007.

Import prices, coupled with weak productivity growth, are the main source of the inflation that the economy is experiencing. Non-fuel import prices rose 0.7 percent in January and have risen at a 5.2 percent annual rate over the last quarter. Import prices are rising across the board over all categories of goods and services and countries. Import prices from the European Union rose by 1.1 percent in January, prices of imports from Latin America rose by 2.8 percent, and the price of goods from China rose by 0.8 percent. The prices of imports from China have risen at a 4.4 percent annual rate over the last quarter.

The producer price indexes will not be released until next week, but the export price indexes suggest that there is likely to be more evidence of inflation at the producer level. Non-agricultural export prices rose by 0.8 percent in January. Non-agricultural export prices have risen at a 7.6 percent rate over the last quarter and a 4.8 percent rate over the last year. Over the last year, all export prices have risen by 6.7 percent, driven by a 28.9 percent rise in agricultural export prices.  

The January CPI indicates that inflation is still on the upswing despite the weakness in the economy. The main source of inflation is higher import prices, which will continue to be a problem in the months ahead as the effects of the falling dollar continue to be felt. The rise in inflation has two immediate consequences for the economy. First it is draining purchasing power, with inflation outpacing wage growth by more than 4 percentage points over the last quarter.

Second, higher inflation makes the Fed’s job far more difficult. Further rate cuts presumably mean that it has abandoned its target of 2.0 percent inflation. More importantly, rising inflation means that lower short-term rates can lead to higher long-term rates, since they create the expectation of a falling dollar and rising inflation. 

Dean Baker is co-director of Center for Economic and Policy Research in Washington, DC. CEPR's Prices Byte is published each month upon release of the Bureau of Labor Statistics' reports on the consumer price and the producer price indexes. For more information or to subscribe by fax or email contact CEPR at 202-293-5380 ext. 102, or morgavan [at] cepr [dot] net.

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