If Inflation Is Low, Why Are Prices High?

“Headline inflation,” as measured by changes in the Consumer Price Index (CPI), was a low 1.5% in 2013 and running at an annual rate of just 2.1% through June 2014.1 Yet when you go to the grocery store or fill up your car at the gas pump, you might wonder what the talk of low inflation is all about.

The answer may lie in the way inflation is calculated. The CPI is an index based on the price of a “market basket” of consumer goods. The cost of groceries contributes only about 8% to the total market basket, and the price of gas at the pump contributes about 5.5%.2 The larger categories of food and energy tend to be the most volatile components of the CPI. That’s why economists, as well as Wall Street investors, place more emphasis on “core CPI” or “core inflation,” which excludes food and energy and demonstrates the longer-run inflation trend of the broader economy

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Food and energy prices are often driven by short-term factors that are beyond the scope of monetary policy. The price of beef has risen in 2014 as a result of the summer 2012 drought, which killed feed crops and forced ranchers to thin their herds. A hog virus has pushed up the price of pork, and the current California drought is likely to increase the cost of fruits and vegetables.3 The price of gasoline can rise and fall due to global oil prices, refinery utilization rates, seasonal demand, seasonal fuel formulations, distance from supplies, and local competition.4

Prices of other goods and services that may be important to you have also been rising, including movie tickets, airline fares, and medical services.5 On the other hand, the cost of televisions and large appliances has fallen.6 So your perception of inflation may depend on what you purchase.

If you’re buying a television, you may not think about the fact that the same TV was more expensive last year. But if that steak at the grocery store costs more than it did last month, you’ll notice and might have to think twice about what you’ll be having for dinner.

1–2, 6) U.S. Bureau of Labor Statistics, 2014
3) USA Today, April 16, 2014
4) U.S. Energy Information Administration, 2013
5) NBCnews.com, May 27, 2014

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2014 Emerald Connect, LLC.