Mixed News on CPI: Headline Rate Improves, Core Rate Accelerates

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The Consumer Price Index (CPI) for August is out. It increased 8.3 percent over the last year, down from 8.5 percent in July. The month-over-month increase in August was 0.1 percent, up from 0.0 percent in July. The Core CPI number is concerning, rising from 0.3 percent in July to 0.6 percent in August. This excludes volatile energy and food prices and gives a more accurate picture of overall inflation. The big picture is that inflation still looks like it has peaked, but remains high. It will almost certainly remain high into next year, no matter what the Federal Reserve or the elected branches do.

The big policy takeaway is that the Fed is likely to be more aggressive in raising the federal funds rate next week at its next Board of Governors meeting. Fed Chair Jerome Powell said last week that he is committed to raising interest rates and keeping the money supply in check for as long as inflation remains high. But he left the amounts up to the Fed’s discretion. Today’s CPI release points them in the direction of acting more decisively.

A deeper story, to which the Fed, Congress, and President Biden should pay more attention, is that this month’s numbers show how important the money supply is in causing inflation.

Not all price increases are due to inflation. One way to tell is if a price increase affects all goods, or just a few goods. Inflation affects all goods. Only a change in the supply of money itself, relative to the supply of real goods and services, can do that. The price level is literally the exchange rate between money and stuff. If their ratio changes, so does the economy’s overall price level.

Other things like supply shocks only raise the prices of some goods. These are not inflation. For example, Putin’s Ukraine invasion caused a spike in energy prices, but that did not affect all goods, just energy and closely related sectors. Tariffs raise the prices of tariffed goods and their close substitutes, but not other goods.

Think of it as the difference between absolute prices and relative prices. Monetary inflation is a price in the absolute price level. The energy supply shock raised the price of energy relative to other goods, but not the overall price level. Same with tariffs, supply chain problems, and other non-monetary issues.

That means CPI was overstating inflation earlier this year, and is understating it now.

Putin’s invasion raised oil prices by enough to show up in CPI, even though it isn’t inflation. That’s why the Core CPI, which excludes volatile energy and food prices, was lower than the overall CPI. Now that energy prices are coming down, August’s Core CPI increase of 0.6 percent is higher than the overall CPI increase of 0.1 percent. More worrying, that core rate is up from 0.3 from July.

That means monetary inflation is still high, which is what we should expect given the timing of the Fed’s COVID-related money creation spree, along with the series of multi-trillion-dollar spending bills from Congress and Presidents Trump and Biden. The Fed’s actions have a lag time of six to 18 months, depending on a host of factors, and we are still inside that window for the worst of the Fed’s stimulus excesses.

It is still likely that monetary inflation has peaked, as have energy prices. That’s good news. But the high Core CPI means that the Fed still has plenty of work to do. Money creation is still out of sync with real economic output.