January PCE Does Not Warrant More Aggressive Tightening

The recent release of the January PCE (personal consumption expenditures) inflation figures sparked the now all-too-familiar scary inflation headlines. But the underlying data do not reveal a “giant inflation shockwave” and the only thing stubbornly high is the widespread level of panic.

One of the best examples of this phenomenon is last week’s Wall Street Journal article by former chairman of the White House Council of Economic Advisers Jason Furman. While most of Furman’s inflation analysis has been pretty calm and levelheaded throughout the current inflation episode, the same can’t be said for his latest article.

It’s difficult to grasp exactly what is driving Furman’s conclusions. While he acknowledges monetary policy “operates with long and variable lags” and argues the “Fed should never react too much to any single data point,” he still calls on the Fed for a “more aggressive course of action” based on the January data. For good measure, he refers to the new release as “the volatile January data, which likely was affected by unusually warm weather and seasonal quirks.”

There are multiple problems with Furman’s prescription for more aggressive tightening, but a cursory look at the data reveals the most obvious ones. (For a different critique, check out Alan Reynolds’ Cato at Liberty post.)

The overall PCE has been calming down for months. Over the previous six months, the average increase was 0.22 percent. Over the prior six-month period (from January to June), the average increase was 0.64 percent. Yes, we could pick some other intervening period or type of average, but the most recent six months would still show an improvement over the prior six months. Until January 2023, this data-based argument was uncontroversial.

But then January 2023 came along, with a monthly increase of 0.62 percent.

Now, when we average the previous six months (from August 2022 to January 2023), the average increase jumps to 0.34 percent. It’s a noticeable increase but still lower than the prior six-month average of 0.64 percent. (If we average the last seven months, our average increase bumps up 0.27 percent. That’s not radically different than the 0.22 percent six-month average from July to December, but let’s leave that sort of question to Alan Reynolds.)

Rather than make this any more complicated than necessary, let’s look at what’s been driving the PCE trend during these last few months.

The clear driver, by major category, has been services. The average monthly increase for the prior six months (July to December) in PCE goods was -0.21 percent. That is, PCE goods saw an average decline in prices. On the other hand, PCE service prices were still increasing. The average monthly increase for the prior six months in PCE services was 0.43 percent.

In January 2023, PCE services still increased at pretty much the same pace as the prior month, with an increase of 0.64 percent compared to 0.56 percent in December. So what changed in January? The change occurred in the PCE goods category. In January, PCE goods prices reversed course and increased.

That is, PCE goods prices jumped 0.57 percent in January, after having declined 0.51 percent in December. (They also declined in four of the prior five months, for what it’s worth.) Obviously, the next step is to examine which item(s) reversed course within the PCE goods category.

The short version: Gasoline prices reversed course. In December, prices in the PCE gasoline and other motor fuel category fell 6.9 percent. Then, in January, they increased 2.3 percent. (This change also tracks with the change reported in the Consumer Price Index, where gasoline prices fell seven percent in December and then rose 2.4 percent in January.) Again, this change took place while PCE services continued to increase at pretty much the same pace as previously.

For anyone interested in a longer explanation, here goes:

The subcategories for durable goods consist of motor vehicles and parts, furnishings and durable household equipment, recreational goods and vehicles, and other durables. For nondurable goods, the subcategories consist of food and beverages purchased for off-premises consumption, clothing and footwear, gasoline and other energy goods, and other nondurables.

The culprit must be one (or several) goods categories that reversed course in January after having fallen in December. Looking through the components of the subcategories reveals the following:

• Motor vehicles and parts prices continued their decrease.
• Furnishings and durable household equipment prices continued their increase.
• Recreational goods and vehicles prices reversed course; These prices fell 0.78 percent in December and then rose 0.6 percent in January.
• Other durable goods prices continued their increase.
• Food and beverages for off-premises consumption prices continued their increase.
• Clothing and footwear prices continued their increase.
• Gasoline and other energy goods prices reversed course; These prices fell 7.28 percent in December and rose 2 percent in January.
• Other nondurables prices continued their increase.

So, as throughout most of this inflationary episode, the “bump” in inflation (using the PCE index) for January is explained by price movements in just one or two categories of goods.

Should we blame the Fed? Should we give the Fed credit for the decreasing fuel prices during the previous few months? I’d argue not, but reasonable people can disagree.

Given the data, it is more interesting to study what monetary policy has–or hasn’t–done to prices in the services category, both recently and long term.

Fully answering these kinds of questions requires more analysis, but it is interesting to note that price increases in the PCE services category typically drive the overall PCE index. From the beginning of the series (in 1959) to January 2023, the price increase in the PCE services category was larger than the increase in the total PCE for 68 percent of those months.

It’s also interesting that since March 2022, when the Fed started raising its rate targets, the average monthly increase in the PCE services category was 0.48 percent, vs. 0.38 percent for the previous 11 months.

Should we blame the Fed for any of these facts? Please stay tuned. In the meantime, though, please stay calm. Even if the month-to-month inflation rate remains close to zero through August 2023, the year-to-year inflation rate won’t drop below three percent until May.