AN EVEN LONGER-TERM COMPARISON OF THE LINK BETWEEN CRB INDEX AND CPI -- THE PAST TWO EXPERIENCES OF FULL EMPLOYMENT ALSO SAW RISING RISING OIL PRICES -- THIS TIME MAY BE DIFFERENT
LONG TERM COMPARISON OF CPI AND COMMODITIES... I wrote a message over the weekend examining the impact that full employment and commodity prices have had on CPI inflation. At the risk of overdoing it, I'd like to finish that article with two more charts. I made the bold assertion over the weekend that every major upturn in inflation over the last three decades has been accompanied by an upturn in commodity prices. Actually, I should have said the last five decades. Chart 1 compares the Reuters/Jeffferies CRB Commodity Index since 1970 to the annual rate of change in the headline Consumer Price Index (black line). The most dramatic part of the chart is the huge upturn in the CPI during the hyper-inflationary 1970s when headline inflation reached nearly 15%. That inflation spike was accompanied by huge gains in the CRB Index. A major commodity peak in 1980 coincided with a peak in the CPI and led to two decades of disinflation. The black arrows show four significant upturns in CPI inflation since the mid-1980s. Those upturns include 1987, 1999, 2002, and 2009. The circles show that every one of those CPI upturns was accompanied by rising commodity prices. I've placed a question mark below the 2016 CPI upturn because it's no longer being supported by rising commodities. [The red arrows show that downturns in the CPI were associated with falling commodity prices]. The main message from Chart 1 is that commodity prices have historically played an important role in the direction of inflation. That's why it's important for economists (like the Fed) to take them into consideration. And why I believe that relying on core inflation that excludes food and energy prices leaves out a lot of valuable information.
(click to view a live version of this chart)
Chart 1
INFLATION UPTURNS IN 1999 AND 2007 GOT HELP FROM RISING OIL... I'm using Chart 2 to elaborate on another point I examined over the weekend. The Fed believes that the current unemployment rate of 4.3% should be enough to boost inflation. It did the last two times that happened. Chart 2 shows the unemployment rate (red line) slipping below 5% during 1997 and 1998 (first red arrow). The bottom box shows CPI bottoming in 1998 and rising during 1999. Chart 2, however, also shows the price of crude oil rising strongly during 1999. The unemployment rate fell below 5% again during 2006 (second red arrow), which was followed by an uptick in the CPI a year later (2007). There again, however, 2007 saw a big jump in the price of oil which no doubt contributed to that year's rise in inflation. So here's the question. Fed models expect full employment to push inflation higher. After all, it did that twice in the last two decades. But is that really what boosted inflation? Or was it rising commodity prices? The red circle to the bottom right of Chart 2 shows the unemployment rate trading well below the Fed's definition of full employment (4.3%). The Fed is relying on that to boost inflation. Unfortunately, commodity prices are dropping this time. If the Fed model works again in boosting inflation, it may have to do it without help from rising commodity prices. We'll find out soon enough which one is the real driver of inflation.
