March 23, 2005 (Prices Byte)
Inflation Jumps in February
March 23, 2005
By Dean Baker
Both the overall consumer price index and the core CPI (excluding food and energy) rose by more than had generally been expected in February. The overall CPI increased 0.4 percent, driven primarily by a 2.0 percent jump in energy prices. The core index increased by 0.3 percent, the largest increase since a 0.3 percent rise in September. The jump in the overall CPI follows two months of near zero inflation, so the annual rate over the last three months is just 1.7 percent. The annual inflation rate in the core over this period is 2.4 percent, exactly the same as the rate over the last year.
While monthly price data will always be somewhat erratic, the inflation numbers for February should not really be a surprise. There has been growing price pressure for some time at earlier phases of production, it is inevitable that higher prices at the wholesale level eventually have an impact on prices at the consumer level.
The core finished goods index has increased at a 4.2 percent annual rate over the last three months. The core finished consumer goods index has increased at an even more rapid 4.8 percent rate over the same period. As recently as 2003, these indices were actually declining.
The situation in the intermediate goods index is even more striking. The core intermediate goods index has risen at a 7.4 percent annual rate over the last quarter and now stands 8.1 percent above its level a year ago. These price increases are driven in large part by higher import prices, which are in turn attributable to the falling dollar and the bidding up many raw material prices.
While the surge in oil prices over the last two years implies even more inflationary pressure, the switch from falling prices to rapidly rising prices at the intermediate and final goods level must eventually show up in consumer inflation. There is some evidence that productivity growth has slowed in recent quarters, but in any case, it clearly has not accelerated from the extraordinary pace of the 2001-2003 period. This means that the switch from falling wholesale prices to rising wholesale prices will show up at the retail level.
There were very few anomalies in the February CPI data. The Medical care index rose by 0.6 percent, driven by 0.7 percent rises in prices for professional and hospital services. The underlying inflation rate in the medical care sector is probably between 4.0 and 5.0 percent, so the February number is not hugely out of line.
Hotel costs jumped 1.1 percent, but this followed a decline of 0.7 percent in January. Public transportation prices were flat in February after falling sharply the prior two months. This will almost certainly be reversed in the March report, since several major airlines have recently raised prices, largely to pass on the cost of higher fuel prices.
At this point, higher energy prices have only been passed on to a very limited extent to the rest of the economy. If energy prices stay high, and possibly even rise further, then it will surely lead to higher inflation in the economy as a whole. It has been striking that thus far workers have been forced to largely swallow the cost of higher energy prices as wages trail the inflation rate by approximately 0.8 percentage points. The pattern of falling real wages, alongside of rapid productivity growth, is unprecedented. At some point, presumably workers will again see rising real wages, which will be another source of inflationary pressure.
Inflation is not about to surge out of control, but it is difficult to believe that just a year ago, the Federal Reserve placed the risks of inflation and deflation as roughly equal. All the trends in the economy - higher import prices, rising oil prices, slowing productivity growth and eventually rising real wages - point to higher inflation in the future. It is not clear that raising interest rates is the best path to counter the upward drift in inflation, but there seems little doubt that inflation will be higher in the months ahead.
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.