Although headline inflation remained high in September at 5.4% year over year,1 there are important compositional changes happening below the headline that show a change in the main drivers of inflation. The source of the changes may lead to longer-run elevated inflation that could outlast current supply chain disruptions.
Inflation: Housing, not Supply Chains
Focus on the Month Over Month
Many observers are focusing on the 5.4% year over year number. But that number summarizes all the inflation that we’ve experienced in the past twelve months— we already know that there was high inflation over the last year. The more important number is the month over month figure which came in at 0.4%. Admittedly, it is almost 5% annualized, but looking through the high oil prices which we know rose rapidly in September, we see that core CPI was only 0.16% month over month, or just under 2% annualized. That’s quite moderate by any definition.
Goods prices skyrocketed between January and July 2021 (see Chart 1). By contrast, in September annualized inflation was just over 1%. Yes, the price level is high, and they may go higher if supply chain issues worsen, but the September print shows a significant reprieve in goods price acceleration.
Transportation services saw a decline of 0.5% month on month—the third month in a row of decline. Most, but not all, of this decline was in airline fares. Medical care services also saw a decline with a -0.1% month on month drop in prices.
Shelter Prices Rising
Then where is the inflation coming from? Housing. Rents rose by 0.5% month on month, the highest since October 1992.
In the summer we began to expect that shelter prices would start rising toward the end of the year. First, owner equivalent rents tend to lag home price increases.
Second, we suspected rents would rise, due to diminishing supply combined with increased spending power by lower wage workers as wages increased.
Of the 0.16% month on month core CPI, 0.13 percentage points (i.e., nearly all of it) came from shelter. Slicing that up even more, homeowners’ equivalent rent makes up 0.09 percentage points. This portion of shelter inflation tends to lag home prices so it primarily communicates known information, that home prices increased recently CPI is playing catch up to that reality. Rent, which contributed 0.04 percentage points to inflation, is probably the most economically significant component, in terms of providing a potential source of chronic and problematic inflation.
Conclusion: Worry About Housing Inflation
The September inflation print did not point to widespread inflation. The main culprit for the high print was energy prices. Looking at core CPI, which excludes food and energy, the print came in below 2% annualized for the month.2 Energy prices should not be ignored, since they could eventually impact other parts of the economy. Beyond that, there was low inflation or outright deflation in many components of the print.
However, the big worry is shelter. Shelter inflation is a slow-moving series, and it tends to be quite persistent, meaning that it is likely to hang around for some time and become more embedded in people’s expectations. Rent could cause additional wage pressure—workers would need to ask for more compensation in order to cover rent. At the moment, rents—while experiencing a large one-month increase—are still not contributing massively to inflation. If they persist, that could create a more chronic inflation situation.
1 Bureau of Labor Statistics September 2021 Consumer Price Index Report.
2 Bureau of Labor Statistics, September 2021 Consumer Price Index Report.
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