April 17, 2007 (Prices Byte)
By Dean Baker
With productivity growth slowing, inflation is likely to creep higher.
A 5.9 percent jump in energy prices pushed prices up 0.6 percent in March. The increase brought the annual rate of inflation in the CPI over the last quarter to 4.7 percent, almost a full percentage point above the pace of wage growth. The core (excluding food and energy) index rose by just 0.1 percent in March, held down by declines in hotel and apparel prices. The core index has risen at a 2.3 percent annual rate over the quarter.
The non-core components are likely to be a source of inflationary pressure for the immediate future. Even if energy prices stabilize, food prices are likely to continue to rise more rapidly than the overall rate of inflation. Food prices increased by just 0.3 percent in March, but rose at a 7.3 percent annual rate over the last quarter. However, the producer price indexes suggest that there are further increases in food prices in the pipeline. The food component of the finished goods index rose at an 18.7 percent annual rate in the quarter. Over the same period, the foods and feeds component of the intermediate goods index rose at a 27.5 percent annual rate, and the crude goods component rose at an incredible 59.3 percent annual rate.
Food prices are extremely erratic, but there appears to be real upward pressure on prices, based in part on the conversion of large amounts of farmland to producing corn for ethanol. This not only raises corn prices, but also the price of competing crops and also feed and beef prices. The net effect is likely to be permanently higher food prices.
While the modest increase in the core index in March is reassuring, there were some anomalies that kept the inflation rate low last month. Hotel prices declined by 2.3 percent in March, knocking 0.08 percentage points off the core inflation rate. This component has declined at a 4.5 percent annual rate over the last quarter. Over the last year, it has risen by 1.3 percent. It is virtually certain to start rising in the months ahead. Apparel also showed a large 1.0 percent drop in March. Apparel prices are always erratic; it is likely that much of this decline will be reversed in the months ahead.
Medical care commodities (largely prescription drugs) also had an unusual price decline, dropping by 0.3 percent for the second consecutive month. This decline helped hold inflation in the medical care component to just 0.1 percent in March. It had risen by 0.8 percent and 0.5 percent in the prior two months.
Outside of the jump in energy prices, there were no important anomalies on the high side in March data. School book prices rose by 1.7 percent in March, but this component accounts for just 0.2 percent of the index.
Housing prices continue to moderate, reflecting the record vacancy rates, with both the rent index and the owners' equivalent rent index (OER) rising by 0.3 percent in March. The annual rate of increase in the OER over the last quarter has been just 3.1 percent. It had been increasing at more than a 5.0 percent rate last spring.
While the core CPI suggests that inflation is still very modest, the producer price indexes do provide reason for believing that inflation could be higher in the future. The core index for finished consumer goods rose at a 3.1 percent annual rate over the last quarter. It rose by less than 2.0 percent in both 2005 and 2006. While the core intermediate goods index rose at just a 1.7 percent annual rate over this period, the core crude goods index rose by 59.8 percent. There clearly are some sources of inflationary pressures at earlier stages of production.
Given the weakness of recent productivity growth, it is likely that some of these price increases will be passed on to consumers. The Fed will have to make a choice as to whether to tolerate somewhat higher inflation and boost the economy with lower rates, or to keep inflation foremost on its radar screen.
Dean Baker is co-director of Center for Economic and Policy Research in Washington, DC.
Prices Byte is published each month upon release of the Bureau of Labor Statistics’ reports on the consumer price and the producer price indexes.