Inflation Takes a Step Back

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Core and headline inflation remain subdued with the Fed’s preferred measure of inflation, Core PCE, remaining slightly below target.

August was a good month on the U.S. inflation front. While I do not like to write an “elevator report,” in this case most cars are heading to lower floors. In a flurry last week, the full run of price measures was down on a year-over-year (YoY) basis. The “headline” Consumer Price Index for All Urban Consumers (CPI) rose 2.7% YoY in August, compared to 2.9% in July. Core CPI, which excludes food and energy prices, rose 2.2% YoY in August, down from 2.4% in July. If you are more goods oriented, the headline Producer Price Index (PPI) rose 2.8% YoY for August, compared to 3.3% in July. Core PPI — excluding food, energy and trade — in August rose 2.9% YoY, slightly up from 2.8% in July. Export prices were up 3.6% Yoy in August, down by 0.7% from July. Import prices — bolstered by a 5% rise in the U.S. dollar in six months — fell to 3.7% in August, down by 1.2% from July.

There was one modest uptick within all the inflation data: real average hourly earnings rose 2.9% YoY in August, compared to 2.7% in July. That is a long way from the January 2015 peak of 2.4%, but a pleasant surprise. Expect to see more wage increases as the labor market tightens. If the Phillips curve is a labor market output rather than an inflation rate input, then the entire concept of slack or NAIRU (the non-accelerating-inflation rate of unemployment) will not hold. A rise in productivity is required to move real wages higher.

This aligns with economic theory, which holds that employee compensation is not a cost-push phenomenon. As a general consideration, it is a truism that slack — especially the unemployment rate — does not drive inflation; inflation is “always and everywhere a monetary phenomenon,” to quote Milton Friedman. Unemployment below the “natural rate” does not cause causes inflation; rather, there will be inflation if and only if there has been a monetary policy mistake. With the Federal Reserve tightening policy, it is possible that inflation will remain in its current trend for longer than market participants, and possibly the Fed, expect.

Please check out page 60 of the Global Perspectives book for more on inflation - consumer price index.

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