EconSouth (Third Quarter 2004)
|Andrew Bauer (left) and Nicholas Haltom are senior economic analysts in the macropolicy section of the Atlanta Feds research department.||
The topic of rising inflation has crept back into many Americans minds recently. Rising prices for milk, steel, and gasoline—among other items—have fueled many articles in the press. These price developments have contributed to a considerable shift in the inflation outlook. As recently as last year, deflation—generally defined as a broad-based decline in prices often associated with weakening aggregate demand—was seen by some as a possibility.
By the end of 2003, core consumer inflation rates, or inflation rates excluding volatile food and energy components, had declined to their lowest levels since the early 1960s. By contrast, commentary during the past several months has dwelt on the prospects of accelerating inflation as core inflation rates turned sharply upward in the early part of this year.
The devil is in the details
Analysts often attempt to confront this issue by examining price changes of major inflation components and then making inferences about the impact of those changes on the aggregate inflation rate. However, such inferences are imprecise. A more rigorous approach is to provide a precise decomposition of the inflation rate by calculating percentage point contributions of components to the aggregate, a technique commonly used to analyze U.S. gross domestic product (GDP).
By highlighting the composition of aggregate inflation, we gain greater insight into the underlying trends in inflation and can make more informed inferences about inflations near-term direction. This method is particularly important because it allows analysts to distinguish broad-based changes in inflation from changes due to movements of only a few components.
Accounting for recent inflation movements
Of course, simply looking at the details underlying the headline inflation numbers by no means gives a perfect understanding of inflation. Inflation is a notoriously difficult economic variable to forecast. Still, by looking at the contributions to inflation by specific components, we can gain a better understanding of movements in aggregate inflation rates as well as make more informed inferences about future inflation.