August CPI: Rising energy prices hide underlying inflation progress

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This month’s Consumer Price Index (CPI) is a jumble of numbers that look like they contradict each other. But they make sense on closer inspection. The big picture is that while 9 percent inflation isn’t coming back, there is still more to do to get it back down to where it should be. When the Federal Reserve’s Open Market Committee meets next week, it should raise interest rates again to help things along. Three of this month’s CPI numbers show why.

First, August’s month-to-month CPI increase was an alarming 0.6 percent. This is triple July’s reading. The main cause was rising gas prices. Since this has nothing to do with the money supply, it also has nothing to do with the great post-COVID monetary inflation. While this is good news for inflation, it also means there is nothing the Fed can do about it. Fortunately, gas prices are still lower than a year ago, even after July’s big increases.

Second, despite August’s big increase, the year-over-year CPI increase rose from 3.2 percent to 3.7 percent. This is an artifact of unusually low readings last summer leaving the moving average. There is a story behind this. Energy prices went sharply up earlier in 2022 when Putin invaded Ukraine. People were learning to adapt by the summer, so energy prices went down from that spike back to more normal levels.

That temporary supply shock led to last summer’s unusually low CPI readings, which measure price changes, not absolute prices. In this case the energy price changes were moving rapidly down, even as they remained high in absolute terms.

Also note that none of that energy price story has to do with the money supply, so it is irrelevant to the Fed’s monetary policy actions. The Fed could not have prevented the energy price spike, nor can it take credit for prices coming back down.

Third, August’s core CPI was 0.3 percent, up from 0.2 percent in July. Core numbers exclude food and energy prices, which, as we have just seen, dance up and down for reasons having nothing to do with underlying monetary inflation. This means core CPI gives a clearer picture of how Fed policies are working than the standard CPI number. It went up, which is concerning. At the same time, it is still lower than most of 2023’s readings so far.

In fact, as economist Justin Wolfers points out, the last three months’ core CPI readings annualize to 2.4 percent—not far above the 2 percent target. We’re almost there.

The last bits of high inflation are lingering in part because markets expect the Fed to abandon its inflation-fighting efforts at the first sign of a possible economic downturn. New deficit spending from an upcoming farm bill and an omnibus spending package will also make the Fed’s job more difficult than it needs to be. But a strong labor market and growing GDP should give the Fed the courage to finish its job without fear of recession.