Confused About Inflation? Check Your Dashboard!
by ed dolan
ed dolan is a senior fellow at the Washington-based Niskanen Center.
Published December 22, 2022
“Prices rose 7.1 percent in November,” wrote the Washington Post in December, responding to the monthly report from the Bureau of Labor Statistics. Although the paper did note that the headline number was down a bit from the month before, it characterized inflation as still “way too high for a healthy economy.”
The New York Times also headlined the 7.1 percent rise in the price level since November of the previous year. It helpfully explained why such numbers worry many: “If price increases remain rapid for a long time, consumers could begin to expect that to continue. They might demand heftier wage increases in response, and if they win those raises, their employers may institute more regular and rapid price increases to cover climbing labor bills.”
I’m worried, too, but for a different reason. My concern is that news reports like these are keeping public attention focused on the wrong indicator at a time when inflation is slowing a lot more rapidly than the headline rate of seven-plus percent suggests. If we look closely, we see that most of that increase — more than six percentage points — took place between November 2021 and June 2022. Inflation from July through November has added just 1.1 more percentage points to the total.
Why does it matter? Because, if families, business leaders and government decisionmakers keep watching a misleading inflation indicator, they risk making serious mistakes. It is as if they were driving their cars while watching the wrong instrument on their dashboards. Let me explain.
The two dashboard instruments I have in mind are the odometer and the speedometer. The odometer tells you how far you have travelled since the last time you reset it. The speedometer tells you how fast you are going.
To show how that relates to inflation, try a little thought experiment: imagine you are going on a long road trip, maybe driving from Pittsburgh to Yellowstone Park. At 6 a.m. on Monday you jump out of bed, grab a thermos of coffee and a donut, and off you go. At six that evening, you stop for the night at a motel. You take one last look at the odometer, and see you’ve come 720 miles in the past 12 hours. Pretty good, no? If you do that well every day, you’ll be at Yellowstone by noon Wednesday.
You check into the motel, go to your room, take off your shoes off and watch the news. At seven, you go down to the neighboring diner. But by now, you have travelled just 660 miles in the past 12 hours. You must be slowing down! By eight, you’ve travelled just 600 miles in the past 12 hours. Slowed down again! Maybe you won’t get to Yellowstone as soon as you hoped!
Really? No one would think that way. When you think about speed, you look at your speedometer, not your odometer. All day long, your speedometer averaged 60 miles an hour. Then, when you parked at your motel, it went to zero. Your speed held steady most of the day, except for occasional traffic or rest stops, and it’s held at zero since you stopped for the night.
So, think of the increase in the price level from a year ago like an odometer reading and the rate of inflation like a speedometer reading. If you do that, you will see that what happened over the past year was this: from November 2021 to June 2022, the consumer price index (the economy’s odometer reading) rose by 6 percent. That’s a 6 percent increase over just 7 months, equivalent to an average annual inflation rate (average speedometer reading) of more than 10 percent per year. And that’s really, really fast inflation!
But then in July, the CPI stopped rising. There was no inflation at all — the economic equivalent of being parked. In August, the price level rose by 0.1 percent. That’s like the change in your odometer when you move your car from the unloading zone at the front entrance of the motel to the overnight parking around back. Your speedometer would barely wiggle while you do that. Inflation picked up just a bit in September and October, but over the entire period from June to November, the average rate of inflation was just 2.5 percent per year, far below the panic zone.
The moral of the story: If you want to know what is happening to the rate of inflation, keep your eye on the speedometer — the monthly rate, stated in percent per year. With that in mind, here is how I would rewrite the inflation story from the Post:
Inflation in November slowed to a rate of 1.4 percent per year. Since June, the rate of inflation has averaged just 2.5 percent per year, well within a range most economists consider consistent with a healthy economy.
Rents and food prices were the biggest contributors to inflation in November. But those were largely offset by decreases in prices for gasoline, electricity, natural gas and used cars. Taken as a whole, the inflation news should come as a relief to consumers, who had been hammered by an inflation rate of more than 10 percent during the first half of 2022.
Does that mean we are out of the woods? Not quite. Families will continue to feel the pain of earlier price increases until wages and salaries have a chance to catch up. Some economists also worry that energy prices don’t have much farther to fall, while momentum will continue to push up the slower-to-adjust prices of other goods and services, at least for a while. As a result, the Fed is likely to ease up on the monetary brakes only gradually until average inflation over several months comes in close to its target rate of around 2 percent per year.