24 February 2016

Don't Be Fooled By Annual Inflation

If you look at Fred right now, you'll see that the CPI is currently 1.3% higher than it was a year ago. This figure can mislead people into think that inflation is a lot closer to target than it really is. To understand this, you need to look at the actual graph for the CPI over the last 12 months or so.
As you can see, the current CPI is really barely any higher than it was last month and is a long way away from the level of CPI inflation consistent with the Fed's 2% annual PCE inflation target. In fact, the CPI is just under 0.03% higher than it was a month ago.

If CPI were to grow at 2% each year, this would require 0.16% inflation each month, which is a whole lot higher than the current 0.03%. Basically, even though the current price level is 1.3% higher than it was a year ago, the price level has not been growing even that fast for quite a while. If you want to see whether or not inflation will be on target, you should look at the compounded annual rate of change, and not percentage change from a year ago.


The new PCE numbers are in and, guess what, inflation is indeed chronically below target; at least the y/y rate is closer to the compounded annual rate of change, though.

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