Another Reason Not to Fear Inflation

The Fed shouldn't worry too much about the recent surge in consumer prices. It's most likely a catch-up after a tough winter.
Don't worry, it's just a game of catch-up.

U.S. inflation has been accelerating in recent months, presenting the Federal Reserve with a tricky question as it decides how quickly to remove stimulus from the U.S. economy: Is the rise in prices a precursor of things to come or simply a "catching up" phase as people begin to spend again after a brutal winter?

Recent data from the U.S. Labor Department have led some to suggest that the long run of very low U.S. inflation could be ending. From Dec. 31 through May 31, the consumer price index -- not seasonally adjusted -- rose a cumulative 2.1 percent. That's equivalent to an annualized inflation rate of more than 5 percent, far exceeding the Fed's target of about 2 percent.

If this is more than a temporary phenomenon, the Fed might have to respond by raising interest rates sooner than expected -- a move that would restrain economic growth and could trigger sharp declines in stock and bond markets.

Some officials at the Fed, though, reportedly do not believe that the surge in consumer prices represents the beginning of a new inflationary trend. After all, in the period just before the winter, from Sept. 30 to Dec. 31, prices actually fell by a cumulative 0.5 percent. Combine the two periods, one with an increase and one with a small drop, and you get an annualized inflation rate since September of about 2.4 percent.

So how can we understand what's behind the official figures and how they can help us plan for the future? To that end, about seven years ago, another professor at the Massachusetts Institute of Technology, Alberto Cavallo, and I (well, mostly Alberto) started computing daily inflation rates for several countries around the world. In what we call "The Billion Prices Project," we collect data from online stores (and other online sources that post prices) and compute alternative price indexes. The online and offline inflation rates are not identical, but they tend to converge over a period of six to nine months.

Consider this chart. One line is the official U.S. consumer price index (its change is the monthly inflation rate). The other line is our daily online price index, known as the PriceStats Online Inflation Index. I have reset both to 100 as of June 1, 2013:


Notice that the online prices kept rising through the winter even as the official CPI descended into deflationary territory. The more recent surge in the official CPI has merely brought it back up to the level of the online index. This supports the view that the official measure of consumer prices is simply catching up after the winter lull.

In other words, the Fed need not be overly worried about inflationary pressures. We'll keep you posted if we see any major deviations, but for the time being, the central bank can keep the stimulus going.

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