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January 5, 2011

2010 In Review: Inflation

In the study of inflation, I tend to focus on analyzing the CPI and the PPI to look for changes in pricing for the consumer (CPI) and changes in cost to produce items (PPI). While the debate over the usefulness of these indicators is beginning to grow (and we will go into more detail on this in a January 12th article), for now, let's look at what each of these indicators did in 2010.

Both the PPI and the CPI were higher in the first half of 2010 than in the second half. Now, many may look at this as a sign that inflation is less of a problem now than it was six months ago. This is not correct. The reason for higher inflation numbers in the first half of the year was because producer and consumer prices were being compared with their counterparts from a year ago.

The first half of 2009 saw unprecedented deflation as consumer and producer prices fell. Comparing 2010 numbers against these would most certainly give you a higher percentage increase than if they were compared with more stable prices (or 2007 prices for that matter).

While I may be dismissive of the first half of the year, the PPI and CPI numbers for the second half provide some important information. First, both the headline PPI and CPI figures are higher than the lows they put in about six months ago. This would tell us that manufacturer costs are rising and consumer costs are rising together. Unfortunately, producer prices take a few months to reach the consumer (unless technology has improved that much), therefore, the increase in PPI tells us that the consumer has more price pressure ahead.

Additionally, the growing spread (albeit small) between the core CPI and headline CPI tells us that food and/or energy prices are increasing. Economists who favor the Fed say that this is caused by investors speculating on food and energy. Everyone else is blaming the Fed's easy money policy for weakening the dollar and making imports (which includes oil) more expensive.

If we think inflation is behind us, we may want to think again. For our PPI and CPI inflation predictions, check out our 2011 predictions article this Friday.

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