December 15, 2005 (Prices Byte)
Plunging Energy Prices Leads to Sharp Fall in CPI
December 15, 2005
By Dean Baker
An 8.0 percent decline in energy prices pushed the CPI down by 0.6 percent in November, the sharpest drop in more than 50 years. The core (excluding food and energy) CPI rose by 0.2 percent for the second consecutive month. This brings the annual rate of inflation in the core over the last three months to 2.4 percent, up slightly from its 2.1 percent increase over the last year. The annual rate of inflation in the overall CPI during this period has been 3.5 percent, the same as the rate of inflation over the last year.
The sharp drop in energy prices was widely expected as the post-Katrina run-up in gas and home heating oil prices has been largely reversed. While gas prices have edged higher recently, the component is likely to be much less volatile in future months.
There are two countervailing forces affecting the core rate of inflation at this point. On the one hand, the improving labor market is leading to a higher rate of nominal wage growth. Nominal wages grew at a 3.5 percent annual rate over the last three months. Compared to just a 2.6 percent rate for the first half of 2005. This more rapid pace of wage growth is also a response to the jump in energy prices over the last two years, much of which still has not been reversed.
Components in which wages comprise a larger share of total costs are likely to be showing higher rates of inflation over the months ahead. This is consistent with a 0.6 percent jump in health care costs in November. In the same vein, the restaurant component rose at a 3.1 percent annual rate over the last six months, a period in which food prices only rose at a 1.4 percent rate. Education prices, which are also driven largely by wage costs, rose by 0.6 percent in November and have risen at a 6.7 percent annual rate over the last three months.
On the other side, the housing bubble has led to a record building boom, which in turn has created a glut of rental housing. This oversupply is pushing downward pressure on rents. The owner's equivalent rent (OER) index (which strips out utility costs, unlike the regular rent index) has risen at just a 1.9 percent annual rate over the last quarter. In some of the areas with the most inflated housing markets, rental inflation is even lower. In Boston for example, the OER has risen by 1.4 percent over the last year; in San Francisco, the OER has risen only 0.3 percent. The rental indexes together account for almost 40 percent of the core CPI, so low inflation in these components will substantially dampen any tendency for the core inflation rate to rise.
With the November PPI not yet available, there is little data on inflationary pressures earlier in the pipeline. The import and export price data provide some ground for concern. While non-petroleum import prices and non-agricultural export prices both fell in November, this follows sharp increases in both in the prior two months, which were revised higher in November. Non-agricultural export prices have risen at a 3.2 percent annual rate over the last three months, while non-petroleum import prices have risen at a 6.5 percent annual rate over this period. These data are consistent with prior months' data in the crude and intermediate goods indexes in the PPI, which showed greater inflationary pressures at early stages of production.
At this point, it looks like core inflation is likely to edge higher in the months ahead, as wage pressure and higher material prices more than offset low rental inflation. However, if wages maintain their recent nominal growth rate, workers will be able to achieve respectable real wage gains. It is not yet clear whether this wage growth will be sufficient to sustain a healthy pace of consumption growth in the presence of a weakening housing market, which will limit the opportunity for borrowing against home equity.
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.