Ah, inflation. It is becoming a divisive topic, though it may have passed that emotion for you and it is time to find something else to verify the inflation you are experiencing. Back in December I saw a very well constructed analysis on ZeroHedge by Jim Quinn. With the December 2013 measures being released this morning by the Bureau of Labor Statistics, I thought I would spend some time updating his numbers. While doing that, I went a little further and started looking in to the core measures of inflation, which the Federal Reserve seems to like as part of their economic reporting and forecasts.
The graphic to the right is the update of the concept from Quinn. While Quinn looked the the prior thirteen years of CPI data, this chart looks at ten years of data (December 2003 through December 2013). The All Items portion has increased 26.7%, or 2.4% annually. The CPI release also includes an Importance measure. The sum of the Importance of each component equals 100. Medical Care has increased in Importance the most over the past ten years as it has moved from 6.074% to 7.163%. Medical Care has increased in cost by 43.8% in those ten years.
There has been some chatter from the White House regarding the amount of inflation in Medical Care and how it has slowed with the implementation of the Affordable Care Act. Obviously, we are too close to that date to actually see a meaningful change in the inflation of Medical Care. Perhaps it is sufficient for politics to respond after one period of change, but that type of release is a double-edged sword. I prefer to take a longer view since most of these components are very slow to change and it is likely these measures are going to continue for several years into the future. Will the Importance of Medical Care continue to increase? I would expect it would since the most expensive period of health care is old-age and we are watching the baby boom generation begin to enter retirement.
Quinn questioned the CPI numbers because the cost of Apparel is so low over the past thirteen years. For the past ten years, Apparel is up 4.6%. The Importance of Apparel is decreasing. Instead of Apparel, I want to focus on Education and Communication. The Importance of this component has increased from 5.948% to 6.779% while the price index has increased by 24.6%. Wait a minute! Did I just indicate this component has seen its price level rise less than the All Items index? You bet I did! Education and Communication includes Tuition for goodness sake. The price index for Tuition is up 63.1% over the past ten years while Communication is down 6.6% over the same period. Communication, in fact, has a higher Importance than Tuition. For all the talk regarding the increase in Tuition, it only has a 3.069% Importance. Of course, if you are paying it, its Importance is quite a bit higher in your budget. Meanwhile, Communication has an Importance value of 3.499%. For those like me who are not paying Tuition but are experiencing a much higher Importance for Communication, the impact of this Component will draw down my own experience of inflation.
Let’s move on to the Core analysis. The Federal Reserve has one favorite Core item, All Items less Food and Energy. I’ll look at that later. There are four other Core measures, two of which I will call out. Since I talked about Medical Care above, I’ll start with that. As I mentioned above, Medical Care is up 43.8%. With the All Items measure at 26.7%, the All Items less Medical Care becomes 25.5%. Even with Medical Care rising the most of the Components and the Importance rising the most, it is still small enough not to make a dramatic difference over the ten year period.
The next Core measure to examine is Energy. It sure does show up really well in the chart with an increase of 78.0%. The Importance of Energy has also risen from 6.723% to 9.561%. That is larger than even Medical Care from the Component analysis. The All Items less Energy has increased 22.6%. That is a noticeable decrease from the All Items measure.
This leads to the final Core measure. If we look at Food and Energy, the Importance has increased from 21.277% to 23.873%. The price measure has increased by 41.4%. Removing that to reach the All Items less Food and Energy measure returns a 21.4% increase. The annualized measure is 2.0%, which is the target the Federal Reserve set for itself. There is a problem, though, before they declare victory. Because of the increase in Importance for the Food and Energy Component, the All Items less Food and Energy has decreased in Importance (from 78.724% to 76.127%). It is hard to agree with the usefulness of a measure when it is counting less of the economy. The annualized increase of Food and Energy is 3.5%, which is 75% higher than the annualized All Items less Food and Energy of 2.0%. Yet, the Food and Energy component is almost 25% of All Items now. Ignoring that Component must be growing harder, but the Federal Reserve’s insistence on ignoring it makes the releases from the Fed less useful. With Medical Care, Food, and Energy leading the Components of the All Items, there is a section of the population that is experiencing very high inflation relative to the rest of the population. Creating a household-based Importance index would be quite interesting. I would expect I am experiencing very low inflation — my Shelter (mortgage payment) is fixed, no Tuition, and very little Medical Care leads me that conclusion.