September Inflation Figures Are No Cause For Alarm

The headlines for last week’s inflation figures look very familiar. The Federal Reserve is “losing the war against inflation” and it can’t let up in the face of the “alarming US inflation figures.”

These kinds of headlines are great for grabbing people’s attention, but otherwise they are not very helpful. As I (and others) have pointed out repeatedly, the year-to-year inflation rates will remain elevated for many more months even if the price level stays perfectly flat. That’s simply the math that we’re stuck with because the initial spike in prices was so high.

But those year-to-year rates say little about whether the Fed is currently failing to tame inflation or if the current rate of inflation is alarming.

To get a handle on these questions, one must look at the month-to-month inflation trends. The year-to-year changes reveal more about how the price level behaved earlier in the year. So, let’s check out those month-to-month changes that were released on October 13th.

From August to September, the Consumer Price Index rose 0.4 percent.

Is that figure alarming? Is inflation out of control? Those terms are rather subjective, but the monthly rate is well shy of the 8.2 percent annual rate reported for September.

As for the monthly trend, starting with July, the previous three rate increases were zero, 0.1, and 0.4 percent. So, the September rate is a bit higher than August when the monthly change was just 0.1 percent. Still, the last three months look better than the previous four, when the CPI increased by 1.2 percent (March), 0.3 percent (April), 1.0 percent (May), and 1.3 percent (June).

For the last three months, the rate of inflation averaged 0.17 percent. It averaged almost one percent for the previous four months.

Then, there’s the bigger question of what should the Fed do? To answer that question, let’s take a closer look at the details underlying the last two monthly CPI releases.

Many of the individual categories driving the overall inflation rate (i.e., driving the full CPI) were essentially unchanged from September to August. Changes in both major food categories and shelter, for example, were identical. New vehicle prices were only 0.1 percentage point different.

One of the main reasons the overall CPI rate was up a bit is that transportation services increased 1.9 percent in September, while it had only increased 0.5 percent in August. Moreover, energy prices fell just 2.1 percent in September after declining five percent in August. (Gasoline prices fell 4.9 percent in September after falling 10.6 percent in August, and fuel oil fell 2.7 percent in September versus 5.9 percent in August.)

A deeper look at those transportation numbers reveals what caused the 1.9 percent spike in September. The transportation services category includes the following three smaller items: (1) Motor vehicle maintenance and repair; (2) Motor vehicle insurance; and (3) Airline fares. From August to September, the first two items changed very little. However, airline fires increased 0.8 percent in September after having declined 4.6 percent in August.

Given that so many of the other CPI categories were essentially unchanged from August, if airline fares had declined at the same rate as the previous month, the overall CPI would have been flat. In that case, the average rate for the last three months would have been very close to zero.

Either way, there’s not much cause for alarm in the September numbers compared to the last few months. When the overall CPI barely moves for two consecutive months, and only increases by 0.3 percentage points because airline ticket prices rose (after having declined in the previous month), it’s hard to say the United States is experiencing runaway inflation.

This finer level of detail also has broader implications for the Fed and the way that it conducts monetary policy. The Fed adjusts its rate targets based on the overall rate of inflation to either slow down the overall flow of credit or boost it. For the last year or so, the Fed has been tightening, trying to slow down the overall flow of credit to slow down the economy and, therefore, the rate of inflation.

Whatever the Fed does right now with rates, it will likely have very little effect on airline fares. The Fed has poor price setting powers regarding specific categories of goods. Monetary policy is a very blunt instrument, and the past year has been a textbook case for why a central bank should not target prices at all.

So, while it makes sense for the Fed to stay its current course–talking tough on inflation and raising its targets if market rates continue to rise–it must avoid the clickbait.

Put differently, the Fed can ignore the dire headlines and avoid tightening so much that it causes a recession. If inflation expectations stay anchored–and there are indications that the Fed has succeeded on this front–the Fed won’t have to go crazy.

As I’ve argued before, journalists can help the Fed manage these inflation expectations. Just give more weight to the recent direction of the price level and stop fixating on the “record” annual rates. Those are going to stay high for many more months unless the Fed engineers a massive, rapid price deflation. And nobody, least of all the Fed, wants that outcome.