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Chart of the Week - US inflation: Don`t be fooled by outliers

  • US CPI rose 0.8% mom in April, the largest monthly rise since 2009, while core CPI (which excludes the volatile food and energy components) rose 0.9% mom, the most since 1982. Our Chart of the Week shows that April’s rise in inflation was driven by outliers, as shown by the relatively small rise in the Cleveland Fed’s median CPI and the trimmed-mean CPI, which remove the effects of large and small price changes of the components in the CPI.1 Indeed, most of the monthly move in headline CPI was due to just four components: used cars and trucks, lodging away from home, airfares and car and truck rental. Together these components contributed 0.5pp, or 60%, to the 0.8% monthly rise in headline inflation.
  • There are two main explanations for these outsized moves. First, the global shortage of semiconductors is weighing on car production and likely boosted the prices of used cars as buyers sought alternatives. Second, the reopening of the economy has boosted hotel prices and airfares amid supply constraints and pent-up demand. For some items (such as airfares and lodging away from home) prices are still well below pre-pandemic levels, while for others (such as used cars and car rental) they are well above.
  • An important question is whether the volatile CPI components are signal or noise. Statistical tests suggest they are mostly noise, and the more one abstracts from volatile components (and not just energy and food) the better one can do, on average, in terms of identifying the trend in headline CPI inflation.2 It is well-known that energy and food prices are volatile, that their disturbances typically get reversed and, hence, are often not related to the general trend in the economy-wide price level. The same reasoning applies to any unusually large or small price changes.
  • The April data has added fuel to the debate about how large and persistent the rise in inflation may be, amid rising commodity prices, supply bottlenecks, huge fiscal stimulus, and pent-up demand for some services as COVID-19 related restrictions are eased. While these effects should prove temporary as supply adjusts to meet demand (the fiscal stimulus is a one-off and pent-up demand should ease later in the year), the supply-demand imbalances could persist for a few months and uncertainty remains very high. For example, it seems likely that the global shortage of semiconductors is partly due to a structural shift towards the faster adoption of technology in response to the pandemic, while supply disruption from COVID-19 related restrictions and health concerns should ease as more people are vaccinated. Importantly, for the rise in inflation to be enduring, the price level would have to keep rising at the same rate, which seems highly unlikely given the temporary, albeit large, nature of the shocks. There remains significant spare capacity in the labor market and the Phillips curve (the empirical relationship between unemployment or spare capacity and inflation) is fairly flat. While inflation expectations can be self-fulfilling, medium-to-long-term inflation expectations remain well anchored, and the Fed’s monetary policy framework is likely to keep it this way.

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