January 18, 2006 (Prices Byte)
Falling Energy Prices Lowers the CPI Again in December
January 18, 2006
By Dean Baker
The consumer price index declined for the second straight month as a 2.2 percent drop in energy prices led to a 0.1 percent decline in the CPI. This decline puts the annual rate of inflation over the quarter at negative 1.6 percent, compared to a positive 3.4 percent rate for the year as a whole. The core (excluding food and energy) CPI rose by 0.2 percent for the third consecutive month. This brings the annual rate of inflation in the core over the last three months to 2.8 percent, up from a 2.2 percent rate over the last year.
The sharp declines in energy prices partially reversed the big jumps in the summer, but the energy index still stands 17.1 percent above its level a year ago. For the immediate future it appears as though it will be going back up, with the December finished goods index showing a 3.1 percent rise in the energy component and with crude oil prices now rising back near their record highs.
The modest rise in core inflation is consistent with the somewhat more rapid wage growth of the last half year being passed on in higher prices. Hourly wages have been rising at close to a 3.4 percent annual rate over the last quarter, compared to a 2.6 percent rate in the first half of the year. Some of this more rapid wage growth is being reflected in more rapid core inflation.
The evidence in recent reports indicates that inflation is likely to edge somewhat higher in future months. Apparel prices fell 0.3 percent in December and have fallen at a 2.3 percent annual rate over the last quarter. While apparel prices may continue to decline, the rate will almost certainly be slower in future months.
Similarly, the vehicle component, which accounts for 10 percent of the core, showed an unusually rapid 2.1 percent annual rate of decline over the last quarter. If car prices continue to decline, it will most likely be at less than a 1.0 percent annual rate.
On the high side, the medical care index increased at a 5.1 percent annual rate over the quarter, the education index increased at a 5.5 percent rate, and the other goods and services index increased at a 4.0 percent rate. While the inflation rate in the other goods and services index may dip slightly, the inflation rate in the education and medical care indexes are probably close to their trend path.
The one big anomaly on the high side is the hotel index, which rose at a 25.3 percent annual rate over the quarter, reversing sharp price declines in the prior two quarters. This index is always erratic, but its underlying rate of increase is probably close to the 3.5 percent inflation rate in the component over the last year. The owner's equivalent rent index is likely to grow at a 2.0-2.5 percent rate, with the rent proper index rising somewhat more rapidly due to rising utility costs.
The producer price indexes continue to show some evidence of increasing inflation at earlier stages of production. The overall intermediate and core goods indexes rose at annual rates of 8.1 percent and 12.2 percent respectively over the last quarter. The core indexes rose at 8.5 percent and 17.2 percent annual rates. The overall finished goods index rose at a 3.6 percent annual rate, although the core consumer goods index rose just 0.5 percent. However, inflation in this index has been depressed by a sharp decline in passenger car prices over this period. The passenger car component accounts for more than 15 percent of the core consumer goods index, and lowered the reported inflation rate by more than 1.5 percentage points over the last quarter.
In the months ahead the economy will be facing weakness due to the slowing of the housing market and reduced borrowing against home equity, while it will also be facing somewhat higher inflation due to more rapid wage growth. If the Fed focuses on inflation, then it will likely accentuate the slowdown.
Dean Baker is Co-Director of the Center for Economic and Policy Research in Washington, D.C.
CEPR’s Prices Byte is published each month upon release of the Bureau of Labor Statistics' reports on the consumer price and producer price indexes.