How Not to Get Fooled by the New Inflation Numbers

We could be on the verge of a golden era of inflation nonsense. In that case, the start date could turn out to be Tuesday morning when new consumer price data was released.

The potential for misunderstandings arises from several forces that clash against each other at the same time. There will certainly be shortages in some goods and services when the economy is brought back to life, which could lead to isolated increases in the price of airline tickets or hotel rooms or, as has recently been the case, certain computer chips.

There are legitimate concerns that the trillions of dollars in government stimulus dollars may push the economy beyond its limits and cause widespread overheating.

However, to be a savvy consumer of economic data, it is important to separate these potential forces from current inflation data, which tells more about the past than the future. Don’t take the backward-looking information in the new report as evidence that these inflation warnings will come true.

The consumer price index in March reflected a 12-month increase of 2.6 percent. which at first glance appears to be an uncomfortably high rate of inflation. (That said, it was higher than that for multiple 12 month periods that ended in mid-2018).

However, March 2020 was not a normal month. The pandemic closed large parts of the economy practically overnight. For this type of experience, it would be difficult not to introduce biases in economic data that make things difficult to analyze. The term for this is “base effects,” the misleading results that can show up year-on-year if something strange happened 12 months ago.

To get a better feel for actual inflation trends, it is helpful to look at the percentage price changes since February 2020, adjusted to reflect an annual rate instead of a 13 month rate. With this measure we see a much more differentiated picture.

Overall consumer price inflation is 2.2 percent with this move – very close to the 2 percent the Federal Reserve is aiming for, especially given that the consumer price index is a few tenths of a percent higher than the Fed’s preferred inflation index.

In the bowels of the new numbers, we see the recovery leading to significant inflationary momentum in different parts of the economy.

For example, gasoline prices have increased 12.3 percent on an annualized basis since February 2020 – perhaps not as dramatic as the 22.5 percent year-over-year price increase reported in March, but still enough to indicate that people living with the prices at the pump are dissatisfied, have something to do complain about other than base effects.


April 13, 2021, 10:35 p.m. ET

In the first few months of the pandemic in particular, energy demands collapsed and the oil and natural gas drills retreated accordingly (remember the strange episode last April when the price of crude oil futures went negative?).

The demand for gasoline, jet fuel, and other petroleum products is finally rising, but power producers, unable to flip a switch and produce enough fuel to meet that demand overnight, are undoubtedly hit by their losses last spring.

Similarly, food prices have risen significantly: an annualized increase of 3.8 percent since February 2020, led by a 5.9 percent increase in meat, poultry, fish and eggs prices. If it feels like proteins are more expensive than they were before the pandemic, don’t imagine that.

Central bankers tend to look past fluctuations in energy and food prices, which tend to fluctuate in a way that does not imply inflation across the economy. However, some elements of “core inflation” also exhibit strange inflationary dynamics, even when corrected for base effects.

For example, used cars and trucks have grown 11 percent annually since February 2020, which is most likely due to many people looking for a way to get around in addition to public transportation.

The downside: The airfare is still well below the prepandemic level and has fallen by 23.9 percent compared to February 2020. There are many reasons to expect planes to be overcrowded this summer, especially on routes to recreational destinations, as newly vaccinated people seem to be stretching their wings. But prices have still not reached their pre-pandemic norm.

Oh, and clothing is still cheaper than prepandemic levels, with an adjusted 2.7 percent decline in clothing prices since February 2020.

The wide variation in these sectors shows the importance of looking more deeply than usual at economic data in the months ahead. Many of the sectors with the most extreme price effects from the pandemic bottomed out in April or May rather than March – which means the year-over-year biases in the numbers will get even bigger over the next few months.

But beyond that, the headlines about inflation or anything else will mean less than usual in the coming months as so many parts of the economy are going through profound changes. Rather, it is better to break things down by sector to understand whether the momentum reflects a one-off setback in the economy or something larger.

The Biden government and the Federal Reserve are putting in a one-time reset with temporary price spikes, followed by inflation and growth stabilizing in 2022. If something more damaging happens, it won’t show up as a few weird data points in 2021, but as broad-based rise in prices across the economy that becomes a cycle of rising prices.

To understand an economy in uncharted territory, the details are more important than the headlines.

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