Today’s inflation data show zero sign of sustained economic overheating

by nyljaouadi1
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Correction: The first paragraph of this blog post has been updated with the correct overall consumer price index (CPI) in March 2021 of 2.6% and “core” measure of the CPI of 1.6%. The initial analysis had accidentally switched the two numbers. The numbers in Figure 1 remain the same.

Today, the Bureau of Labor Statistics (BLS) reported that the overall consumer price index (CPI) in March 2021 was 2.6% higher than in March 2020, while the “core” measure of the CPI (which excludes volatile food and energy prices) was 1.6% higher than a year ago. Given that these are noticeable (if modest) increases over recent months’ year-over-year inflation rates, some might be tempted to argue that this data should make policymakers worry about economic “overheating” stemming from “too much” fiscal support provided in recent recovery legislation. This is clearly wrong, for a number of reasons:

  • The data released today do not show that prices have risen rapidly since recovery legislation passed—instead they just show that prices plummeted during the near-total shutdown of large swaths of the economy a year ago in response to the COVID-19 shock.
    • Measured on an annualized basis from February 2020—before the COVID-19 economic shock—inflation in March 2021 was running at just 1.5%.
    • Measured since October—shortly before the $2.8 trillion in additional relief spending provided by legislation in December 2020 and the American Rescue Plan (ARP) in March—inflation is running at an annualized rate of 1.3%.
  • Non-price measures continue to show enormous degrees of economic slack, so there is no conceivable way that the U.S. economy was overheating in March 2021.
    • Employment remains 8.4 million jobs below what prevailed in February 2020. If we add in growth in the working-age population, the jobs gap remains over 10 million—larger than it was during the worst parts of the Great Recession of 2008-09.
    • Nominal wage growth (adjusting for composition) remains very tame. True “overheating” has to come from the labor market and this isn’t happening.
    • Nominal consumption spending in the U.S. economy is slightly lower than it was a year ago, before the COVID-19 shock.
  • Even in coming years, and even if growth in economy-wide spending outstrips growth in the economy’s productive capacity for a long stretch of time, damaging inflation that would require policymakers’ response is highly unlikely to appear.
    • Even several years of inflation above 2% would still not make up for years of too-slow price growth over the past 12 years, and making up for these years of too-slow price growth would go a long way to reestablishing the credibility of the Federal Reserve inflation target. This is an opportunity, not a threat.
    • Counterbalancing recent expansionary fiscal actions like the ARP is the steady and significant drag on spending growth imposed by the enormous rise in inequality in recent decades. As inequality has redistributed income from households that spend most of their income to households that save much more, this puts a steady anchor keeping demand growth depressed. Until this structural headwind to growth is addressed, persistent overheating is highly unlikely to happen.
    • Long-lasting upward spirals of wages and price inflation that may call for action from policymakers require relatively balanced bargaining positions of workers and employers to sustain. This does not describe today’s U.S. economy and so such spirals will not happen in coming years.

Today’s data are mostly about what happened in March 2020, not March 2021

As a number of useful explainers have pointed out, the uptick in year-over-year inflation reported in today’s data is mostly a function of the sharp drop in the price level that happened a year ago as the COVID-19 economic shock hit. To show that today’s inflation numbers are not driven by “overheating” following the economic recovery packages passed in December 2020 and last month, in Figure 1 below we show the year-over-year “core” inflation measure reported by the BLS today, along with two alternative measures: an annualized rate of inflation based on price growth since February 2020, and the annualized change in prices since October 2020.

The first alternative measure (measuring inflation since February 2020) includes data from the period of the extreme COVID-19 shock, but it doesn’t use it as the base in the inflation formula. The second measure is more volatile since it’s measuring a shorter period of time, but the latest data point (all the way on the right) would pick up any inflationary pressure stemming from the surge of fiscal spending that began at the end of last year to now. As can be seen in the figure, even today’s inflation measure—the one that allows the base period to be set in the very unusual months when large swaths of the U.S. economy shut down completely in March 2020—is not really close at all to even reaching the 2-2.5% comfort zone of the Federal Reserve. (Wonky aside: the widely-reported 2% inflation target of the Fed is based on another inflation measure that consistently runs below the CPI data in this figure, so to translate their target to this figure requires raising it a bit.)

In short, today’s slight uptick in year-over-year inflation rates (but still showing inflation beneath the Fed’s 2-2.5% target) captures something unusual that happened a year ago, not anything unusual that is happening currently. This same logic will hold for the next few months of inflation data, which will be using a “base” period that includes the near-total shutdown of large swaths of the U.S. economy that happened a year ago.

Removing March 2020 base effect shows no unusual inflationary surge: Year-over-year core CPI inflation and two alternative base periods

Date March 2020 February 2020 October 2020
Feb-2019 2.1% 2.1% 1.7%
Mar-2019 2.0% 2.1% 1.8%
Apr-2019 2.1% 2.1% 2.0%
May-2019 2.0% 2.1% 1.9%
Jun-2019 2.2% 2.1% 2.1%
Jul-2019 2.2% 2.2% 2.2%
Aug-2019 2.4% 2.2% 2.2%
Sep-2019 2.3% 2.3% 2.0%
Oct-2019 2.3% 2.3% 2.0%
Nov-2019 2.3% 2.3% 1.8%
Dec-2019 2.2% 2.2% 1.5%
Jan-2020 2.3% 2.3% 1.6%
Feb-2020 2.4% 2.3% 1.7%
Mar-2020 2.1% 2.2% 1.4%
Apr-2020 1.4% 1.6% 0.3%
May-2020 1.2% 1.3% 0.0%
Jun-2020 1.2% 1.4% 0.0%
Jul-2020 1.6% 1.6% 0.6%
Aug-2020 1.7% 1.8% 1.4%
Sep-2020 1.7% 1.7% 2.5%
Oct-2020 1.6% 1.7% 2.8%
Nov-2020 1.7% 1.7% 2.7%
Dec-2020 1.6% 1.6% 1.7%
Jan-2021 1.4% 1.5% 1.0%
Feb-2021 1.3% 1.4% 0.9%
Mar-2021 1.6% 1.5% 1.3%
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The data below can be saved or copied directly into Excel.