Skip to content

Too Early to Celebrate “Strengthening” Consumer Prices

mall 2The Consumer Price Index for January 2016 has attracted a lot of attention since it was released last Friday. But a look inside the numbers raises questions about its overall message of economic strength.

The overall CPI stayed flat this month, mainly due to the decline in energy prices. But core prices rose 2.2 percent in January from a year earlier, the fastest rate since June 2012, and by 0.3 percent from December last year, the fastest monthly growth since August 2011.

Many cheered this news as a signal that inflation is picking up and the economy is growing at a solid pace. However, inflation in the short term can be affected by various factors, and not all of them are consistent with a positive outlook for economic growth.

First, inflation can be driven by consumer demand. Higher demand usually results in higher prices. If strong demand is the cause of higher consumer prices, it is undoubtedly good news for the economy.

But retail sales growth, an important measure of consumer demand, showed a decline in December from November (the January retail sales report shows a rebound, but it would not be reflected in the January CPI). Personal disposable income growth, another measure of consumer demand, stayed at its average rate in recent months. This is to say that strong consumer prices in January were likely not caused by strong consumer demand.

On the other hand, reduced supply could also push up consumer prices. If this is the case, then the higher prices will not last long since producers and suppliers will waste no time in catching up with demand. Industrial production, a measure of supply, declined for three consecutive months in the last quarter of 2015. Due to price stickiness (prices respond to changes in demand and supply with lags), lower supply from October to December last year manifested itself in higher consumer prices in January.

In fact, supply may already be catching up to demand. The latest industrial production data for January showed that it grew at 0.9 percent in January from last December, the fastest monthly growth since December 2014. With much improved supply, consumer price growth for months ahead will likely slow down.

Click here to sign up for the Daily Economy weekly digest!

No comments yet

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: