Core Inflation Slows in April

Following a decline in March, the Bureau of Labor Statistics reported that consumer prices rose by 0.2 percent over the month of April, largely reflecting energy and food prices as well as shelter prices. Excluding energy and food prices, “core” inflation decelerated from 0.2 percent to 0.1 percent as shelter prices, which represent the largest share of the consumer price index (CPI), decelerated from 0.4 percent to 0.3 percent. However, since shelter accounts for the largest share of consumer inflation then its 0.3 percent monthly growth rate accounted for a sizeable portion of core inflation over the month.

At the same time, the unemployment rate fell and 10-year inflation compensation was flat, although 10-year inflation expectations ticked up slightly. Historical analysis indicates that energy prices impact headline inflation while the labor market and inflation expectations more consistently track core inflation. Since 2012, inflation expectations seem to track core inflation more closely than the relative decline in the unemployment rate.

A previous post illustrated how an expectations augmented Phillips Curve provides a framework for thinking about the sources of pressure on consumer price changes. Essentially, current consumer inflation, ∏t, is related to inflation expectations, ∏e, labor market conditions, a(U-U*) , and an added price shock, v, such as energy prices. More precisely, the relationship took the form as shown below where (U-U*) represents the actual unemployment rate minus the economy’s natural rate of unemployment.

∏t = ∏e – a(U-U*) + v;


The release indicates that the CPI rose in part because energy prices switched from a monthly decline in March to a monthly increase in April. The figure below illustrates the relationship between energy prices and consumer inflation. It indicates that oil prices influence energy prices which in turn impact consumer prices. More recently, the decline in consumer prices in 2009, 2010, and the deceleration in consumer inflation in 2015 parallels changes in energy prices during those same periods. In recent months, the acceleration in oil price growth has tracked the rise in consumer inflation. The impact of energy prices on consumer prices is one reason some analysts prefer “core” inflation.

Core inflation tends to be less volatile than “headline” inflation largely because energy price swings are excluded. The figure above also illustrates that core inflation tracks 10-year expectations of inflation closely, particularly since 2000. The figure above shows how “survey based measure of longer-term inflation expectations” reported by the Federal Reserve Bank of Cleveland and “market-based measure of inflation compensation” have moved slightly above two percent in recent months consistent with the acceleration in core inflation. Since 2012, the survey based measure of 10-year inflation expectations has tracked core inflation closely.

Labor market conditions also inform inflation. More specifically the difference between the actual unemployment rate and the economy’s natural, or non-accelerating inflation, rate of unemployment (NAIRU). The NAIRU represents the rate of unemployment that does not stoke faster inflation and represents those that are unemployed because they are switching jobs or because they don’t have the skills needed for employment. Intuitively, when the actual unemployment rate is below the NAIRU, employers may have to pay higher wages fill job openings and these higher costs filter through to consumer prices. One would expect an inverse relation between inflation and the gap between the unemployment rate and its natural rate. A smaller or increasingly negative gap should coincide accelerating inflation and a less negative or growing gap should correlate with a deceleration in inflation or outright price declines.

The figure above tracks the relationship between inflation, both headline and core inflation, as well as the unemployment rate gap. As discussed in an earlier post in regards to potential GDP, the estimate of the economy’s NAIRU by the Congressional Budget Office was lowered to reflect the impact of the Tax Cuts and Jobs Act. The dark green line uses the pre-tax cuts NAIRU and the light green line uses the current NAIRU. The difference between the two lines is very small in 2018.Although the figure above shows the impact of energy prices, labor market conditions seem to have broadly played a visible role as well although the early to mid-1970s saw an increase in both inflation and the unemployment rate gap.

In response to the 2001 recession, the unemployment rate gap rose, but headline inflation was volatile. However, core inflation did slow and then accelerate as the unemployment rate gap was declining. In 2009, the sharp increase in the unemployment rate gap coincided with a decline in headline inflation but the first figure above suggests that the decline in headline inflation reflected energy price decreases. However, the share increase in the unemployment rate gap did coincide with a slowdown in core inflation. As the unemployment rate gap began to shrink between 2010 and the 2011, core inflation accelerated. In subsequent years, the unemployment rate gap has continued to fall, but core inflation did has not significantly continued to accelerate and the decline and acceleration in headline inflation over 2014 and 2015 was in response to energy prices as illustrated by the first figure.

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