It’s a month too soon to be stressing out over US inflation

Inflation rose 5% in May 2021. But the real picture will emerge only with the data for June, which won’t have to contend with the plunging prices in the early months of the pandemic. …

US consumer prices shot up 5% year-on-year in May, according to data released by the Bureau of Labor Statistics on Thursday—the steepest such rise since the depths of the recession in May 2008. Core inflation, another measure that omits food and energy prices, seemed even more superheated: 3.8%, the highest since June 1992.

Economists had already been predicting that prices would surge by around 4.7%. So the actual 5% figure fed anxieties that the US is settling into a sustained period of inflation—that the Fed is mistaken in its belief that this inflation is “transitory.”

But the details in the data suggest otherwise. And more importantly, the way in which the numbers are calculated suggests that we should really be waiting for a month—for the release of the June data in early July—before we begin to fret.

How base effects warp price rises and inflation

At the heart of the inflation calculation is what is known as the “base effect”—the effect of computing the year-on-year inflation numbers for the past three months by comparing them to the March-April-May period in 2020. In those three months, when the pandemic was sinking its teeth into the US economy, states were locked down, businesses were shut, supply chains were tangled and knotted. As a result, prices either fell or stayed abnormally low; April 2020, for instance, witnessed a 0.7% drop in prices from the prior month.

The bottomed-out prices in those three months are a distorting artifact. They make the year-on-year prices of March through May 2021 seem more superheated in comparison. But by June 2020, as the US’ enormous economic stimulus took hold, prices began to rise again. In a few weeks, when we’re able to compare the prices from June 2021 to those from June 2020, we’ll have a fuller, truer picture of inflation—and of how “transitory” it promises to be.

Used car prices are driving inflation

Other aspects of Thursday’s data are telling as well. A full third of the overall price rise in May was due to the surge in used car prices: 29.7% as compared to May 2020, the largest such year-on-year increase in nearly half a century. Used car prices rose in April too, and the reason is still the same: lagging production of new cars because of supply and transportation bottlenecks. Other sectors that saw strong price increases—air travel, say, or hotel bookings—can also be classified as “pandemic-hit,” meaning that their levels last year were abnormally depressed. Virtually no one was flying in May 2020; no wonder a comparison makes it look as if prices in May 2021 were soaring.

Tellingly, in less pandemic-hit sectors, such as food at home or rent, the rise in prices was more tempered. Year-on-year, inflation for food at home clocked in at 0.7%, and for rent at less than 2%.

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