The Big Idea

A sticky inflation situation

| March 22, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

When it comes to inflation, “sticky” has two meanings.  The academic definition refers to prices that tend to change infrequently.  A more popular meaning in the inflation debate is that the rate of increase in prices is high and coming down only slowly.  For the Atlanta Fed’s Sticky-Price CPI gauge, both definitions apply currently.

The Sticky-Price CPI

The Atlanta Fed has crafted an alternative gauge of underlying inflation called the Sticky-Price CPI.  I have written about it in the past, but the pickup in headline and core inflation indicators in January and February makes this a good time to revisit the metric.

Economists have looked at the frequency at which different prices change.  One academic research effort found that of the 350 detailed categories used in the CPI, the median frequency of price changes was once every 4.3 months.  Fed researchers built on this paper by dividing the 45 major components of the CPI into the 21 that change more frequently than 4.3 months and the 24 that change less frequently.

The former grouping was labeled the “Flexible-Price CPI” and includes such categories as most of the food and energy sectors, used vehicle prices, hotel rates and several apparel components.  In theory, the Flexible-Price CPI should be quite sensitive to the state of the economy. That is, prices for these items closely track frequent shifts in supply and demand.

The latter group was labeled the “Sticky-Price CPI” and includes categories like rent, OER, medical care services, motor vehicle insurance, household furnishings and operations and recreation.  In theory, because firms selling “sticky” products and services move their prices infrequently, in many cases because the adjustment costs of altering prices may be high, the sticky price index tends to be more forward-looking.  That is, firms will want their prices to account for inflation over the period between the infrequent price changes. The Sticky-Price CPI consequently can be thought of as offering particular insight into inflation expectations and the underlying rate of inflation.

I like the Sticky-Price CPI for another reason.  As I have laid out on a monthly basis, I believe that it is helpful to strip the noisiest categories out of the CPI, because big one-off swings in these line items can distort headline and core changes in any given month.  In contrast, the sticky-price components typically exhibit less random noise and offer a reasonably accurate view of the underlying trend.  In this sense, the Sticky-Price CPI approximates my Ex-Fearsome-Five core CPI measure.

Flexible prices

The Atlanta Fed Flexible-Price CPI has cooled dramatically over the past year or two.  The gauge has moved from a high of nearly 20% into slightly negative territory (Exhibit 1).

Exhibit 1: Atlanta Fed Flexible-Price CPI

Note: The data show the 12-month change in the Flexible-Price CPI.
Source: Atlanta Fed.

This descent reflects the unwinding of supply chain snags for a variety of goods, most notably used motor vehicles.  It appears that the disinflation more or less stabilized as of last summer, as the year-over-year change has been fluctuating near zero since August.

Sticky prices

In contrast to flexible prices, the Sticky-Price CPI has decelerated but remains elevated. The year-over-year advance has declined from its peak but is still running above 4%, far too high for the Fed to take comfort (Exhibit 2).  For reference, this gauge resided in a 2% to 2.5% range in the years before the pandemic.

Exhibit 2: Atlanta Fed Sticky-Price CPI

Source: Atlanta Fed.

One might take comfort from the Sticky-Price CPI by noting that the year-over-year advance has been steadily coming down, a trend that continued in February.  However, a more granular examination of the Sticky-Price CPI points to trouble. Look at the 3-month annualized percent change (Exhibit 3).  For this more sensitive way of slicing the data, the rate of inflation bottomed out at 3.6% (still too high) in July but has been accelerating since then, reaching 5.0% in February, the highest reading since April.

Exhibit 3: Atlanta Fed Sticky-Price CPIa closer look

Source: Atlanta Fed.

This divergence between the year-over-year advance and the higher frequency changes mirrors what we are seeing in the core figures.  For the core CPI, the year-over-year increase has continued to inch down, but the 3-month annualized rise bottomed out in August at 2.6% and has since rebounded to above 4%.  For the core PCE deflator, the 3-month annualized advance fell to as low as 1.6% in August and again in December but surged to 2.6% in January and may speed up further to over 3½% in February.

Too soon to declare victory

Chair Powell on Wednesday declared that the FOMC is hopeful that the pickup in core inflation in early 2024 will prove to be a bump in the road but is keeping an open mind. The Atlanta Fed Sticky-Price CPI, more than the traditional core indices, suggests that the degree of cooling seen late last year probably exaggerated the underlying reality of the broad inflation picture and that, even if the early-2024 results are somewhat inflated, the rate of underlying inflation is still far too high for the Fed to consider declaring victory any time soon.

Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556

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