The Consumer Price Index (CPI) is the Federal government’s measurement of monthly and annual inflation at the retail level. The statistic is created by the Bureau of labor Statistics using a “secret shopper” survey whereby firms throughout the country are surveyed on the prices of a market basket of goods and services. Much of the methodology is kept secret so that individual firms or industries cannot knowingly influence the inflation index number. Economic theory suggest that price stability is a good thing and that changes in prices should reflect supply and demand factors rather than government policies; however, over the past 100 years, the government has maintained a fairly inflationary policy, meaning that notwithstanding market conditions, prices generally rise over time.
The Bureau of Labor Statistics’ (BLS) projection of CPI for the month of December 2012 was released showing no increase in overall price levels for the month. This means that inflation for 2012 as a whole was only 1.7 percent. Even though CPI as a whole was quite muted, some products experienced significant inflation in 2012, with fuel oil up by 3.6 percent, medical care prices up by 3.7 percent and the cost of housing rising by 2.2 percent. Other costs were down sharply, specifically natural gas prices which fell by 2.9 percent and used cars which were 2 percent cheaper in 2013 than in the prior year (this makes sense as the “cash for clunkers” program had led to a shortage of used cars).
Overall in 2012 no major category of the CPI outside of medical care suggested inflation of much more than 3 percent, with overall food prices increasing by 1.3 percent, restaurant and bar costs up 2.5 percent, overall energy costs up by 0.5 percent and the cost of household goods like furniture and appliances actually down slightly (0.4 percent). The price of shelter (which represents almost a third of the CPI) was up 2.2 percent reflecting a turnaround in the housing market. This, along with the fact that energy prices are likely to rise again in 2013 suggest much higher inflation in the coming year.
The low inflation numbers are both good and bad for businesses and industries. First, low commodity price increases in 2013 suggest that firms were able to maintain or enhance profits – which is one reason for rising equity prices. In fact, commodity prices overall rose by just 1.0 percent in 2012. On the other hand, low CPI suggests that most companies have not been able to take much in the way of pricing, and have had to continue to focus on productivity improvements to increase margins. At the same time, both businesses and consumers should be concerned about continued steep increases in the government controlled medical and education sectors both of which experienced inflation rates 100 percent higher than the overall average.
We have forecast higher prices for the past 4 years resulting from high levels of government debt and what we believe is an overly expansionary monetary policy. Fortunately we have been wrong about this; however, I think the reason that inflation has been slow is because the economy has been kept artificially weak by bad government policies, over-regulation, and an unwillingness to invest in future production. If this is the case, low inflation rates could rapidly turn if the economy were to grow only modestly faster. We continue to think that companies and individuals would be well placed to keep inflation in the back of their minds when making decisions with a medium-term (3 to 5 year) time horizon.