STUDYING HISTORY TO MEASURE THE IMPACT OF FULL EMPLOYMENT AND COMMODITY PRICES ON CPI INFLATION -- THE FED IS BANKING ON FULL EMPLOYMENT TO BOOST INFLATION -- BUT THAT'S UNLIKELY AS LONG AS COMMODITY PRICES ARE FALLING
A HISTORICAL COMPARISON... A big debate is going on regarding the path of inflation. Inflation figures have slipped during the second quarter. So have commodity prices. Normally, falling commodity prices signal lower inflation. Fed economists argue that the current low unemployment rate should boost inflation. The Fed generally defines "full employment' as a reading below 5%. There's some truth in all of those arguments. So let's look at history for some guidance. The black line below Chart 1 plots the annual rate of headline CPI inflation (including food and energy). The arrows show periods when the monthly rate of change of the CPI turned up or down. The brown bars show the Reuters/Jefferies CRB Commodity Index. The red line plots the unemployment rate. The last two times the unemployment rate fell below 5% was in 1997/1998 and 2006 (red circles). In both instances, an uptick in the CPI ensued (1999 and 2007). Score two for the economists. But they also got a lot of help from rising commodity prices.
(click to view a live version of this chart)
Chart 1
RISING COMMODITIES ALSO BOOSTED CPI ... Chart 1 shows that a rising CRB Index in 1999 also helped boost the CPI. It did so again in 2007 (brown up arrows). In fact, every major upturn in the CPI over the last three decades has been accompanied by an upturn in the CRB Index. That was true between 1986 and 1990, 1998 to 2000, 2003 to 2008, 2009 to 2011, and again in 2016. So here's the question. What really drove the CPI higher in those two prior instances of full employment? Was it rising commodity prices or an unemployment rate below 5%. Both probably played a role. A full employment rate and rising commodity prices probably combined to boost the CPI. But it seems doubtful that a full employment rate by itself would have been enough. The same may be true in the current situation. According to the Fed, the current unemployment rate of 4.3% should be enough to boost inflation. But commodity prices are falling. The CRB Index has lost -12% this year, with crude oil losing more than -20%. The CPI has fallen from 2.7% in January to 1.8% which is the lowest level of the year. [Core inflation is also back below 2% (1.7%)]. If history is a guide (and it usually is), commodity prices will have to start rising in order to reach the Fed's goal of CPI inflation over 2%.
MORE RECENT HISTORY... Yogi Berra once said that you can learn a lot by looking. And that's all that we're doing here. Just looking. Chart 2 (below) compares the CPI with commodity prices over the last ten years. One thing that immediately jumps out is how closely the monthly CPI rate of change tracks the CRB Index. [You'll find that linkage going back to the 1970s]. CRB bottoms in 2009 and early 2016 coincided with CPI upticks. CRB peaks in 2008, 2011, and 2014 resulted in a lower CPI. Which again brings us to current situation. The CPI rate rose throughout 2016 to briefly exceed the Fed's target of 2%. The CRB Index bounced during that year as well. From the February 2016 bottom, the CRB Index gained 15%, and crude surged 60%. That certainly contributed to the rebound in the CPI. The problem now is that commodity prices are falling again. The last red arrow in Chart 2 shows CPI slipping as well. The red line above Chart 2 shows the unemployment rate at 4.3% which is below the Fed's target rate for full employment. The Fed is banking on that to boost inflation. But that seems doubtful while commodity prices are falling. History suggests that rising commodity prices are a necessary ingredient in rising CPI inflation. Fed economists might consider taking some time from studying economic models of inflation to look at some actual price charts. It's amazing what you can see when you look. Even Yogi knew that you can't see something if you don't look at it.
