Why Americans are so confused about what's happening with inflation
When July inflation figures came out last week, economists and federal policymakers cheered. Compared to June, overall consumer prices were flat.
Compared to last year, however, prices rose by a blistering pace of 8.5%, conservative commentators pointed out, complaining that zeroing in on the monthly inflation rate is disingenuous.
Which number should Americans look at? Experts say both—in addition to a bunch of other indicators if they want to get a sense of where prices are going.
“I find the entire debate a little bit silly,” said Employ America research analyst Alex Williams.
How to look at CPI
The consumer price index, which measures a specific basket of goods and services, is not a precision instrument. It’s an average that obscures big drops and big hikes in particular items. In July, for example, higher prices for shelter and food were canceled out by lower energy prices.
CPI also misses details about how prices move for people in different income brackets or demographic groups. (There are many ways in which the CPI could be improved.)
What it can tell us about the economy is limited, so Williams suggests looking at other kinds of data or news that suggest where prices are going in conjunction with monthly CPI.
For example, to put monthly inflation numbers into context, Williams cross-checks specific sectors in the index with what purchasing managers in those industries are saying, which sheds light on where prices might be headed in the future.
The annual CPI rate, on the other hand, captures what happened 12 months before the most recent figure. This is why some economists suggest that media outlets report both figures in headlines when the two numbers are vastly different, confusing average Americans.
Why do people have trouble understanding CPI?
A great deal of the confusion over inflation could be a generational issue, according to Justin Wolfers, a University of Michigan economics professor. Anyone under the age of 60 in the US hasn’t experienced inflation in their adult lives, he said.
“Separate from the general confusion, there’s ideologues cherrypicking and trying to confuse people,” Wolfers said.
Wall Street economists mainly care about the monthly number because they know what has happened with inflation in the prior months, he added. Annual increases, meanwhile, matter for workers who are negotiating salaries, so they can ask employers to match the cost of living.
“Every number is an answer to a question,” Wolfers said. “If what I’m trying to do is predict the future path of inflation, the so-called core measures do a better job.” Core inflation excludes energy and food prices, which tend to go up and down based on fleeting issues.
Where does inflation go from here?
July may be a one-off in terms of inflation data. “I’m not crazy enough to say that just because headline inflation rose by zero last month that it’s going to rise by zero again in any future period,” Wolfers said.
He expects prices in the next few months to increase, but not by more than 1% vs. the previous month.
“Some months as low as a quarter and some months as high as three-quarters...somewhere in that range,” Wolfers said.
