Commentary

Why Not to Panic on Inflation

RELAX — inflation is not galloping out of control. At least, the number pointed to as proof of a crisis doesn’t tell us anything like that.

Behind the panic was this week’s release of the latest Consumer Price Index figure — a 5 percent rise from last June. Actually, it was the number insiders call “headline CPI” — because headline writers regularly use it for “The Sky Is Falling” eye-grabbers.

Bloomberg’s headline for the June release was “US Consumer Prices Climb by the Most Since 2005 The New York Times chose “Inflation in June rose at the fastest rate in 17 years.”

Three years? Seventeen? The Washington Post topped both — “Consumer Prices Rise at Fastest Pace in Quarter Century.” That absurd comparison was based on a single month — June 2008 vs. June 1982. This makes no more sense than claiming that February’s zero increase in the CPI proved inflation was the lowest since 1955.

You see, “headline CPI” jumps around — a lot — mainly because the price of oil, itself highly volatile, plays a major role in the overall number.

So Bloomberg had some point in comparing June’s 5 percent year-to-year CPI with September 2005. But that September ‘05 figure, 4.7 percent higher than a year earlier, was so high simply because the price of crude oil was up 42.7 percent over the same period. Just 13 months later, crude was down 5.6 percent and the CPI was only 1.3 percent higher than a year earlier.

The Times similarly looks at May 1991’s “headline CPI,” up 5 percent from a year earlier — when the price of oil was up 16.5 percent. Yet the CPI dropped to 2.9 percent within five months, as oil fell 35.3 percent.

Bottom line: “Headline CPI” gives us a fair picture of what has happened to the cost of living over the past month or year. But it’s near-useless for telling us where inflation is headed in the future.

It's energy inflation

That’s why analysts regularly look at “core CPI” — the headline number, with volatile food and energy prices factored out. But excluding food prices makes little difference except to distract attention from the main issue, so many of us prefer to exclude only energy prices — and look at the “ex-energy” CPI.

The graph above compares year-to-year percentage changes in two measures of inflation since 1966. The ex-energy CPI excludes only direct energy costs, such as gasoline and utility bills. The headline CPI includes everything.

And either measure makes it quite clear that comparing today’s inflation with a ’70s-style stagflation is preposterous.

Nor were the terrible inflations of 1973-75 and 1978-82 “caused” by oil prices, as many believe. Inflation then was skyrocketing even as measured by the ex-energy CPI: It was up by 8.2 percent in the 12 months ending in December 1973, and by 11.7 percent a year later. It was up 9.1 percent in the 12 months ending in December 1978 and 11.1 percent a year later.

Today, “headline inflation” is much higher than the ex-energy rate because the price of crude oil doubled over the past year. The only way the headline rate could remain as high as 5 percent over the next 12 months would be for the price of crude oil to double again.

But if crude doubles again, inflation won’t be our problem — because that would trigger a nasty global recession, and oil prices always collapse in recessions.

The ex-energy CPI does include indirect effects of higher oil prices, such as the impact on costs of transportion and petrochemicals. But ex-energy inflation always slowed after previous spikes in oil prices ended, contrary to recent Fed anxieties.

Despite the indirect effects, ex-energy inflation remains at 2.9 percent over the past year, up from 2.8 percent in December. That means headline inflation will likely trend down over the next 12 months, even if oil prices stay high. If oil keeps falling, then headline inflation will drop below the ex-energy rate, and the ex-energy rate will itself drop thanks to cheaper transportation and petrochemicals.

An inflation rate moving closer to 3 percent than 5 percent will be nothing to brag about. But hysterics comparing the latest headline inflation with 1982 will soon look even more foolish than they already do.

Alan Reynolds, a senior fellow at the Cato Institute, wrote Income and Wealth.