Buyers beware: Inflation rising after several sluggish years
© Getty Images

The Bureau of Labor Statistics reported Wednesday morning that year-on-year inflation, as measured by the Consumer Price Index, ticked up over 2 percent in December — the first time it has done so in two-and-a-half years.

Consumer prices were 2.1 percent higher than a year ago, up from a 1.7 percent increase in November. Increased shelter and gasoline prices were cited as the main cause of the uptick. 

Inflation is closely watched by policymakers because it affects consumers’ purchasing power and because increasing inflation can be a major threat to the stability of the economy.

The increases in necessities documented in the report, such as gas, housing and food, will definitely interest consumers.

At the very least, the report attaches concrete numbers to things that everyone has been noticing lately, like increased prices at the pump.

However, the Federal Reserve will be looking beyond the headline numbers in Wednesday's report. Fed policymakers will look closely at the rate of inflation that sets aside food and energy prices.

They remove food and energy prices because those categories tend to vary more than other prices and because their changes often have little to do with the health of the economy.

For example, a frost in Florida can have a big impact on food prices, but that will not tell us much about where economic output is headed in the near future.

Leaving out food and energy, the CPI came in at 2.2 percent in December.

Despite the significance of the CPI, Fed officials rely more on the Personal Consumption Expenditures index when assessing inflation. The PCE is coming out on Jan. 30. 

After that release, the Fed will again try to determine whether inflation has reached its critical 2 percent target.

Since 2008, inflation has consistently registered below 2 percent; a far cry from the pre-financial crisis years when inflation regularly exceeded 2 percent. 

If anything, today’s data will likely reinforce Fed officials’ judgement that rising inflation is more of an issue than falling inflation.

That would make it more likely (note the cautious language here) that the Fed will be raising interest rates again fairly soon.

Other inflationary factors will influence the Fed’s thinking. Most of all, an increasingly tight labor market has led to modestly increasing wages, with more likely to come.

Wage pressures have been reinforced by legal minimum wage increases in no less than 19 states on Jan. 1.

Additionally, the trend toward rising oil prices seems to be well-entrenched now. Crude oil has pushed past $50 a barrel, with few signs of stabilizing.

Higher oil and gas prices should gradually filter through the rest of the economy, putting upward pressure on all prices.

But, as Fed Chair Janet Yellen commented, there is a “cloud of uncertainty”.

If the new administration broadly sticks to its agenda of lower taxes, fiscal stimulus and drastic deregulation, the immediate effects are likely inflationary.

Tax cuts and increased deficits should lead to increased spending, which would push up prices and inflation. The effects of any changes in regulation would only be seen in the data over a longer period of time.

There are also offsetting factors that make the inflation outlook less dramatic. The stronger dollar dampens price increases, tending to decrease the price of imports.

Also, the slow economic activity of many of our main trading partners decreases the demand for U.S. exports.

Couple that with the enormous uncertainties surrounding President-elect Trump's trade policies and it is no wonder that the Fed, along with much of the world, is in "wait-and-see" mode. 

 

Evan Kraft specializes in the economics of transition, monetary policy and banking issues as a professor at American University. Kraft served as director of the Research Department and adviser to the governor of the Croatian National Bank. 


 

The views of contributors are their own and not the views of The Hill.