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Inflation is not a tide that lifts all boats equally

  • 26 November 2021
  • 5min read

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It’s hard to follow the news without encountering scary-sounding reports about inflation. They’re often based on broad inflation measures like the consumer price index, which has risen 5% or more year over year for six consecutive months since May, the longest such streak since the early 1990s.

The implication, if not the explicit message, is that the cost of everything is skyrocketing, but that’s not entirely true. Underneath the headline inflation numbers, there’s a wide variation of price increases. The cost of some things, such as transportation and gas, are rising at a significant rate. Others, such as rent and medical care, are only modestly more expensive.

I looked at those components of CPI, as well as food, apparel and electricity, because they have the longest overlapping historical data, back to 1936. I wanted to compare what’s driving inflation today with previous inflationary episodes. What I found is that, contrary to general perception, prices typically don’t rise at the same time or pace, even during bouts of high inflation.

In fact, with few exceptions, there has been little to no correlation between the annual inflation rates of the seven components I examined. Price changes of food and clothing appear to move in tandem most of the time (0.7) and to a lesser extent so do rent, medical care and electricity (0.6). But in general, rising prices in one category don’t signal price movements elsewhere. (A correlation of 1 implies that two variables move perfectly in the same direction, whereas a correlation of negative 1 implies that two variables move perfectly in the opposite direction.)


That variation in price movements was evident during the worst inflationary episodes. When prices surged from 1945 to 1948 after World War II, the cost of food and clothing rose more than 10% a year while that of gas and electricity barely budged. There was less variation during peak stagflation from 1977 to 1981, but inflation rates for individual components still varied a lot. Gas prices jumped 15% a year while food and clothing rose 9% and 5% a year.


That variation is even wider today. Year-over-year changes in transportation costs and gas prices have averaged close to 20% over the past six months while rent and medical care have risen by an average of just 1% to 2%. Food, clothing and electricity are closer to the lower end of that range, rising by an average of 4% to 5%.


That’s useful to know. For one, it helps focus governments’ response. If the recent spike in inflation is mostly due to higher transportation and energy costs, and to a much lesser extent food and clothing, then policy makers should redouble efforts to restore global supply lines and encourage more energy production in the meantime.

Knowing what’s driving headline inflation also helps inform the debate about whether it might be transitory. To the extent higher inflation is mostly due to Covid-19’s grip on the flow of goods, as opposed to services like medical care that are less dependent on supply chains, then price increases should slow as the pandemic wanes. That kind of visibility might even calm inflation fears, which can help price stability by discouraging consumers from binge shopping in anticipation of higher prices.

And yes, inflation may still be transitory. Beginning in August 1990, the CPI rose more than 5% year over year for seven consecutive months and then gradually declined to less than 3% several months later, which is roughly the long-term inflation rate in the U.S. Where CPI goes in the coming months will be telling, but for more insight now, look at the numbers behind headline inflation.

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    Disclaimer

    Sources for all data: US Bureau of Labor Statistics, Bloomberg, Nov 2021.

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