Tuesday, February 9, 2016

Breaking Down US Inflation Rates by Category

Since 2000, the Federal Reserve has focused on the Personal Consumption Expenditures price index for its primary measure of inflation, rather  than the better-known Consumer Price Index. (For the reasons behind this choice and distinctions between the measures, see this post on "Consumer Price Index vs. Personal Consumption Expenditures Index," from January 17, 2012.) The PCE price index can also be broken down into a bunch of price indexes by type of product, and comparing these subsidiary price indexes with the overall PCE price index offers some views on long-term patterns of what drives inflation.

The best-known breakdown of the PCE price index, and the one used by the Fed, is to focus on the "core" price index that excludes food and energy prices. The blue line shows the "core" index, while the red line shows the overall PCE index. As you see, they are much the same over time, but the overall index fluctuates more because it includes the comparatively volatile energy and food prices.

Just how volatile are energy prices? The price index for "energy goods and services' appears in blue. it's highly correlated with the rises and falls in crude oil, and as you can see it dances around considerably. (Everything is measured here as the percent change from a year earlier.) The reason that overall PCE price index is currently lower than the "core" index in the figure above is largely because the core index doesn't include energy.

Although the core PCE price index also leaves out food, the volatility in prices for food is a lot less extreme than for energy prices. The blue line shows the price index for food, with the overall PCE price index appearing in red.

Another way to slice up the overall PCE price index is to look at changes in the price index for goods and for services separately; moreover, we can separate out durable and nondurable goods, and further separate out some more specific categories of interest. For example, the price index for durable goods appears here in blue, with the overall PCE price index again appearing in red for comparison. What's interesting here is that inflation in durable goods prices has been consistently below the overall inflation rate for decades; indeed, the inflation rate for durable goods has been consistently negative since the mid-1990s. Part of the reason here is that technological change in some durable goods like those related to computing and information technology has been so extreme that goods have become cheaper over time; another part of the reason is the role of cheap imported products in holding down prices.

The blue line in the next figure shows a subset of the durable goods price index, which is the price index for the subcategory of "video, audio, photographic, and information processing equipment and media." Again, for comparison the overall PCE price index is shown by a red line. In this subcategory, the inflation rate has actually been negative for most of the years back to 1960, except for a period in the 1970s. Moreover, the deflation rates in this subcategory have consistently been around 10% per year and sometimes even lower for two decades.

In comparison, the price index for nondurable goods, shown below by the blue line, is much closer to the overall PCE price index. Nondurable goods includes energy, which helps to explain why the blue line fluctuates more than the red line which again shows the overall PCE index.

The price index for services, on the other side, tends to be somewhat higher than overall PCE price index, as shown in the graph below by the blue line often being a bit above the red line in recent decades. About two-third of consumer expenditures on on services, rather than goods.

Within the category of services, what are some of the major subcategories that are tending to keep inflation higher in this broad area? The blue line in this figure shows the inflation rate for housing and utilities (which includes both the price of renting a home and an imputed price when owners "rent" their own house to themselves) which tended to be lower than the overall PCE inflation rate shown by the red line in the 1970s and 1970s, but was often higher from the 1980s up through the early 2000s.

Health care costs in the PCE index include both what people pay out of pocket, and also the costs of health insurance premiums payed by employers on people's behalf. Inflation in those health care costs, as shown by the blue line, was consistently higher than the overall PCE index for most of the time up to the last decade or so.

The price index for education services includes what people spend on higher education, as well as private schools. Inflation in this area has been consistently above the overall average of the PCE price index.

I'll also toss in one component of education that isn't included under services, but rather under goods: the price index for educational books. For several decades, it has been rising more rapidly than the overall PCE index.

These sorts of figures and tables aren't the final word, of course. There are hard questions in measurement of inflation that have to do with making sure that when you measure price changes you also adjust for changes in quality, and also adjust for changes in the patterns of what people are buying. The PCE index arguably makes such adjustments  better than the Consumer Price Index, but the problems remain large.

But with those kinds of concerns duly noted, it seems fair to say that over the long-term, the process of US inflation is a balancing act between price inflation for services that rise at a higher-than-average rate and price inflation for durable goods that rises at a lower-than-average rate.