Two Percent Inflation

From yesterday's Bureau of Labor Statistics Consumer Price Index Summary we learned that consumer prices rose 0.5 percent in August, which, when added to the previous 11 months works out to be a 12 month increase of 3.6 percent.

Now, everybody just calm down ...

Yes, this number is getting dangerously close to 4 percent, but there is no need to be alarmed. Core inflation, which strips out volatile food and energy costs, moved up just 0.1 percent and was a docile 2.1 percent during the last year.

Fasting pedestrians and bicyclists have nothing to worry about.

If you need more convincing that you shouldn't be worried about prices that seem to be rising everywhere but at Wal-Mart and in the inflation statistics, take a look at the Median CPI over at the Cleveland Fed - a monthly increase of 0.2 percent and an annual rise of 2.1 percent.

See? Now there are two measures of inflation at 2 percent and just one closing in on 4 percent. This is what's called benign inflation, or more accurately, benign inflation reporting - a key ingredient to the monetary policy mix over the last decade or so.

The Number Two

It seems there is something that is just magical about 2 percent inflation. Or, maybe it's just the number two - kind of like 2 percent milk, we suppose. Non-fat milk looks too watery to be very tasty and there are too many calories in whole milk, but 2 percent milk ... why, you can drink as much of that as you want and it tastes good.

Two percent - it's kind of like zero percent, really. Two is so harmless and benign - "my two cents", "two bits". And, harmless and benign is how we like our inflation reported. As long as people hear "inflation" and "two" in the same sentence over and over and over, maybe they can continue to not pay too much attention to rising prices all around them.

We have our own thoughts about benign inflation as we discussed some time ago here. It seems that in addition to the well known housing misinformation and quality adjustments in the CPI, there is the curious relationship between falling prices for imported goods manufactured in China and rising prices for services provided in America - they seem to neatly offset each other.

John Williams also has a nice analysis of some of the flaws in CPI here and Jim Puplava did a fine job in his discussion of the Core Rate here.

When Will They Notice?

The question today, and for the foreseeable future, is when will ordinary Americans notice that what they hear about inflation and what they experience in their daily lives bear (or is it bare?) little resemblance to one another?

Maybe soon.

If you are making nine dollars an hour working at Wal-Mart and now it costs you $60 to fill up your tank instead of $30 or $40, that's a difference of a half a day's wages after taxes. That should be noticeable - Wal-Mart customers have noticed it.

When times are good and you can whip out a credit card or debit card and fill up your tank for $30, then go buy groceries at reasonable prices, people tend to not look too closely at receipts. Many people don't bother to look at the total cost at the time of purchase or at the end of the month. Have you ever noticed the gas receipts left behind by motorists who seemingly couldn't care less about what they paid?

When you think about it, why would anyone pay any attention to a few extra dollars here or there, or another hundred dollars or so at the end of the month when home values have been rising as they have in recent years? When you've got an extra thousand or ten thousand in home equity at the end of the month, why would anyone notice monthly expenses that continue to rise month after month - medical expenses, tuition, gasoline, heating oil, utilities?

Just pay the bills and get on with the serious business of figuring out what to do with all that home equity that is just sitting there.

With rising short term rates affecting both HELOC payments and ARM adjustments, doubling of minimum credit card payments next month, rising gasoline costs, rising heating costs this winter, and stagnating home prices in some areas, many people will soon realize that while they can still believe that their milk is 2 percent, they won't continue to believe that their inflation is 2 percent.