Consumer inflation has averaged 2% for 18 years

We have been living in a 2% inflation world for the past 18 years. Sometimes that fact gets obscured by the sheer volatility of year-over-year inflation, which has ranged from -2.1% to 5.6% in the past two decades. Super-volatile oil prices are largely to blame for this; having ranged from $19 to $140 per barrel over this same period. Chart #1 helps illustrate this. The blue line is the total CPI, whereas the red line excludes energy prices. The Personal Consumption Deflator, on the other hand, has been running a bit over 1.5% for the past two decades; it’s fairly typical for the CPI to register more inflation than the PCE deflator, since the deflator is more responsive to shifts in consumer preferences (consumers, being generally smart and thrifty, shy away from high-priced items, preferring instead cheaper substitutes).

Ex-energy, the year over year change in the CPI has ranged from -.7% to 3.1%, as seen in Chart #2. Taking out food prices in addition (which would be the so-called “core” rate of inflation) would make a very small difference. Energy is much more volatile than food prices, so that is my preferred measure of underlying inflation.

The price of oil has been by far the most volatile of any commodity. Take out oil, and you get a much better idea of where things are going on a year-to-year basis.

Chart #4 is interesting since it shows how much energy costs have shrunk as a share of total personal consumption. Energy today is only 3.4% of personal consumption expenditures, whereas it was almost three times more in the early 1980s. Food and energy together account for 11.7% (food is 8.2%).

Chart #5 compares the price of oil to the prices of non-energy commodities. Note the relatively tight correlation between the two. More importantly, note how the scale for crude goes from 1.4 to 280 (i.e., crude prices have increased by a factor of almost 200 times!), while the scale for non-energy commodity prices increases by a factor of only about 6 ⅔. Huge difference, yet very correlated! This confirms my preference for non-energy inflation as the best measure for underlying inflation trends.

The August readings for the CPI (+2.1% ex-energy over the past year) should put an end to speculation that the economy’s virus-induced collapse would result in deflation. It’s likely the Fed won’t tighten for quite some time, but there is no reason at all to worry that they need to be easier. If I had to bet, I’d say the next tightening comes before the market expects it; that is to say, I think the risks are skewed to inflation exceeding expectations over the next few years.