A Key Index of Inflation in the US Has Come Down

There are signs that inflation is coming down.  While still early and preliminary, recent monthly figures for the inflation indices that many economists (and Federal Reserve Board members) focus on, suggest a break from the inflation rates seen earlier in 2022.

On January 27, the Bureau of Economic Analysis (BEA) released its most recent monthly report on Personal Income and Outlays, with estimates for December 2022.  The figures are part of the National Income and Product Accounts (or NIPA, often referred to as the GDP accounts) that the BEA is responsible for.  The accounts include estimates for Personal Consumption Expenditures (PCE), and to put those into real terms the BEA also estimates the price indices that apply to those expenditures.  Items are weighted as they are for the Personal Consumption component of the GDP accounts.

The prices shown are all seasonally adjusted and at annual rates.  There is a great deal of volatility in the month-to-month figures, so it is best to focus on the trends over several months.  Many commentators focus on the year-on-year figures (a 12-month moving average), and these are shown as the red line in the charts.  But a 12-month period is long, and one does not know if changes observed are due to recent events or to events of close to a year ago.  For this reason, I prefer the shorter 3-month moving average figures (in blue).  As one can see, major changes in the 3-month figures will often give a good indication of where the 12-month figures will soon go.

The first chart at the top of this post shows values for the overall rate of inflation (where all personal consumption expenditures are included), while the second chart shows the values for core inflation (where food and energy items are excluded).  Core inflation is a better indicator of inflationary pressures, as food and energy costs are largely commodity items with prices that go down as well as up.  Their fluctuations are often wide.  Other prices are typically more “sticky”, and hence the core inflation index that excludes the volatile food and energy components serves as a better indicator of the trends.

Three-month core inflation rates have come down from around an average of about 5% (remember that all figures are at annual rates) during most of 2021 and 2022, to 3.6% in the 3-month period ending in November and then 2.9% in the period ending in December.  The overall PCE inflation rate fell earlier, from a higher level, and by more.  It was generally between 7 and 7 1/2% from late 2021 to June 2022 (and hit 8.6% in the 3-month period ending in March), but then fell to a range of between 2 and 4% since September.  In the three months ending in December, it was just 2.1%.  Interestingly, the 6-month change for the second half of 2022 was also 2.1% (at an annual rate).

Energy prices are a major part of this.  While the core inflation rate removes energy items from the basket of items included in the inflation index (along with food), those energy items will be those directly purchased by households.  That is, the core inflation index removes items such as gasoline purchased for your car or natural gas to heat your home.  But energy prices will also affect other prices indirectly – for example from the cost of fueling the trucks that bring items to the markets.  Based on the index of energy prices used in the computation of the overall PCE inflation index, energy prices rose sharply in March 2022, following Russia’s invasion of Ukraine in late February.  But the energy price index reached a peak in June 2022 and has since fallen almost to where it was in February 2022, just prior to the invasion.  Whether it will fall further is not known, but a further major fall from where it was in December is probably not likely anytime soon.  In this case, the inflation indices may not fall much further in the coming months, and may well bounce back up a percentage point or so.  But the trend is likely still downwards.

As noted before, these figures are still early.  One should expect fluctuations going forward, as there have been in the past.  And inflation in the next few months may well be higher than in the last few.  But the figures do suggest that inflation has come down, and has come down despite still very tight labor markets.  The unemployment rate was 3.5% in December – matching the lowest it has been since 1969, more than a half-century ago.  And the labor market has been tight for some time.  Unemployment was in the range of just 3.5 to 3.7% from March onwards, which is about the range of month-to-month statistical uncertainty in the estimates.

Despite these figures on inflation, there have been at least some prominent economists arguing inflation will remain high for an extended period.  Ken Rogoff – a professor at Harvard and a former chief economist for the IMF – authored a major article for the recent November/December issue of Foreign Affairs titled “The Age of Inflation”.  In it he wrote:

the world may very well be entering an extended period in which elevated and volatile inflation is likely to be persistent, not in the double digits but significantly above two percent.

Nouriel Roubini (often nicknamed “Dr. Doom” for his frequent pessimism, but who correctly forecast the 2008 financial collapse) has argued similarly, saying that high inflation will be with us for a very long time.

There are, of course, also economists arguing the other side – arguing that inflation has been and will be coming down.  The most well-known is perhaps Paul Krugman.  Another would be Jason Furman, a professor at Harvard and previously a chair of the Council of Economic Advisors during Obama’s presidency.  While they had argued earlier, in 2021, that inflation would not rise as far as it did and for as long as it did following the massive Covid spending packages of both Trump and Biden (totaling $5.7 trillion in federal government spending, or a huge 12.8% of GDP of 2020 and 2021 together), they now recognize and acknowledge that mistake.  But it is important also not to err in the opposite direction.

We will see what develops.  But based on what inflation has been in recent months, it very much looks like there has been a break from earlier levels and that the trend is downwards.