November 16, 2006 (Prices Byte)
Falling Energy Prices Lead Price Decline in October
November 16, 2006
By Dean Baker
overall CPI fell by 0.5 percent in October, driven largely by a 7.0 percent
decline in energy prices. The core (excluding food and energy) CPI rose by 0.1
percent, slightly less than had been expected. The annual rate of inflation
over the last three months has been -2.9 percent, as energy prices have fallen
at a 43.8 percent annual rate over this period. The annual inflation rate in
the core over the last three months has been 2.3 percent, down somewhat from
the 2.7 percent rate over the last year.
were a few anomalies that lowered the core inflation rate in October, notably a
0.7 percent drop in apparel prices (this follows large increases in the prior 2
months), a 1.2 percent decline in used car prices, a 0.6 percent drop in video
and audio products, and a 0.5 percent decline in hotel prices. On the other
side, the 0.7 percent rise in phone prices is not likely to be repeated.
medical care and education components continue to show substantial inflationary
pressure, rising by 0.3 percent and 0.6 percent, respectively. It appears that
rental inflation is abating. The owners' equivalent rent measure, which is not
affected by utility prices, has risen at a 3.9 percent annual rate over the
last quarter. This compares with inflation rates of 4.5 percent and 5.5 percent
in the prior two quarters. The record housing vacancy rates will continue to
put downward pressure on inflation in this sector in the months ahead.
The moderation of inflation was
also evident at earlier stages of production. The overall finished goods index
declined by 1.6 percent in October, driven by sharp declines in both food and
energy prices. The core finished goods index also declined, dropping by 0.9
percent, mostly as a result of large declines in the prices of cars and light
While these price declines were
clearly anomalies, the October price reports provide considerable evidence that
inflationary pressures at the wholesale level are dissipating. The overall
intermediate goods index fell by 1.1 percent, while the core index was flat.
The overall crude goods index fell by 10.5 percent and the core index dropped
1.3 percent. Over the last three months, the core intermediate goods index rose
at a 4.8 percent annual rate, down from a 5.9 percent increase over the last
year. The core crude goods index has declined at an 11.6 percent annual rate
over this period, compared to an increase of 20.1 percent rate over the last
The anomalies in the October
price report make the pattern of inflation going forward difficult to gage. The
extraordinary price drop in the overall CPI has clearly ended now that energy
prices have stopped their plunge and may be creeping up again. However, even
the future of the core index is difficult to assess. Inflation in the rental
component, which comprises almost 40 percent of the core index, is likely to
slow gradually in the months ahead. There continues to be moderate inflation in
other components, which may pick up slightly if productivity growth stays on
its recent weak path (1.3 percent over the
last year) and nominal wage growth remains near 4.0 percent.
The producer price indices
indicate that there is less inflationary pressure at earlier stages of
production. This is especially notable with construction materials, which had
been experiencing substantial price increases earlier in the year due to the
building boom. With both the overall and core intermediate and crude goods
indices showing rapid rates of inflation earlier in the year, there was reason
to believe that these higher prices would show up in higher inflation at later
stages of production. There is far less basis for this concern with the most
recent price data.
It is not clear how the Fed is likely to respond
to these reports. Core inflation remains close to 2.5 percent, somewhat higher
than the Fed's target rate. However, the economy is clearly weakening as
falling house prices are limiting the ability of consumers to borrow.
Dean Baker is Co-director of Center for Economic and Policy Research in Washington, D.C.
Prices Byte is published each
month upon release of the Bureau of Labor Statistics’ reports on the consumer
price and the producer price indexes.