Monday, April 11, 2011

Rising Commodity Prices Do Not Necessarily Lead to Higher Core CPI Consumer Inflation

We hear a lot of talk about how rising prices for copper, cotton, oil, and other commodities are signaling that inflationary pressures are building up in the general U.S. economy, implying a direct and tight connection between commodity prices and consumer prices.  For example, Atlanta Fed President Dennis Lockhart said recently that rising commodity prices are creating “inflation anxiety." But what exactly are the implications of rising commodity prices for core inflation, and how closely are those two variables related?  

That's the question posed in a new Chicago Federal Reserve Bank research paper by Charles Evans and Jonas Fisher. As the chart above of annual PPI inflation rates for industrial commodities and the annual core CPI inflation rates shows, the answer to the question is "not very much."  From the introduction of the paper:

"The recent run-ups in oil and other commodity prices and their implications for inflation and monetary policy have grabbed the attention of many commentators in the media. Clearly, higher prices of food and energy end up in the broadest measures of consumer price inflation, such as the Consumer Price Index. Since the mid-1980s, however, sharp increases and decreases in commodity prices have had little, if any, impact on core inflation, the measure that excludes food and energy prices.

Some economists argue that rising commodity prices are inflationary and, therefore, require a tightening of monetary policy.  Others say rising commodity prices have sometimes led to inflation and sometimes not. Therefore, a monetary policy response may not be required. In this Chicago Fed Letter, we empirically assess these views by conducting a statistical analysis of quarterly data on commodity prices, inflation, and monetary policy since 1959. We find that since the mid-1980s, after the big oil shocks and the tenure of Paul Volcker as chairman of the Federal Open Market Committee (FOMC), the reactions of both core inflation and the federal funds rate (the monetary policy instrument) to shocks in oil and other commodity prices have been extremely modest."

8 Comments:

At 4/11/2011 7:59 PM, Blogger Benjamin Cole said...

The all-time best post by any economist ever. Congrats to Dr. Perry.

Please send a copy of this post to that idiot and clucking Chicken Little, Richard Fisher, of the Dallas Fed.

The Inflation Chicken Littles would draw the monetary noose around our necks, and suffocate the economy before the recovery gains steam.

BTW, you want to know a nation that licked inflation: Japan.

Oh, btw, stocks and property lost 75 percent of value in Japan in last 20 years, and wages are down.
But hey! The yen is up.

 
At 4/11/2011 8:59 PM, Blogger Bruce Hall said...

"Top Federal Reserve officials sent a clear signal that the Fed is unlikely to follow the European Central Bank in lifting interest rates from rock-bottom levels anytime soon, playing down the idea that soaring commodity prices will lead to broader U.S. inflation."

http://online.wsj.com/article/SB10001424052748703841904576257261599060184.html

 
At 4/11/2011 9:05 PM, Blogger aorod said...

This market is elevated by cheap money..when the cheap money goes, so go the markets....

 
At 4/12/2011 6:15 AM, Blogger geoih said...

You mean, if you take the prices of the most important things that people buy, which are increasing, and average them with the prices of the far less important things people buy, which are not rising as much, the average is much lower than the rising prices of the important things?

Oh, the magic of modern macro-economics. Mixing heterogeneous things together with convoluted math to give the illusion of knowledge.

 
At 4/12/2011 7:39 AM, Blogger juandos said...

"Rising Commodity Prices Do Not Necessarily Lead to Higher Core CPI Consumer Inflation"...

Sunrise doens't necessarily lead to daytime either, right?...

 
At 4/12/2011 7:51 AM, Blogger Eric H said...

"...core inflation, the measure that excludes food and energy prices."

They forgot housing. I guess it's a good thing those are totally unnecessary and don't represent any significant percentage of the average citizen's expenditures.

Why don't the Federal Reserve Cartel and the BLS just pick some metric we don't pay for at all, like air (despite ongoing efforts by the Democrats), and claim there is no core inflation.

It would be just as meaningful.

 
At 4/12/2011 12:06 PM, Blogger Ron H. said...

"You mean, if you take the prices of the most important things that people buy, which are increasing, and average them with the prices of the far less important things people buy, which are not rising as much, the average is much lower than the rising prices of the important things?"

Worse than that, if you just don't include the rising prices of important things, you can show that inflation is nothing to worry about.

 
At 4/13/2011 1:33 PM, Blogger VangelV said...

The way I see it, Fed officials are trying to justify Bernake's Havenstein moment by pretending that when oil goes up by a factor of three US businesses are not effected by it and that US drivers do not experience the price increases. This is about one thing; choosing the destruction of the dollar over an outright default.

We have a choice. We can believe that there is no inflation or we can actually look at the real world and see what is going on. We can choose to believe that there are no consequences to our actions or we can admit that in the end we tend to get what we deserve.

 

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