More On: oil prices
In summary, previous oil price surges have resulted in frightening year-over-year inflation figures, as they did this year.
Since Federal Reserve Chairman Jerome Powell first mentioned cyclical or COVID-related features of inflation, there has been a lot of talk about them, as “transitory” (an ambiguous phrase now retired), critics repeatedly seized on year‐to‐year changes in price indexes as evidence that inflation was instead accelerating every month.
However, as I previously stated, the stubborn rise in year-to-year inflation—even as monthly rates slowed in the third quarter—was due in part to base effects (prices indexes were often flat or falling during the 2020 pandemic) and, more importantly, compounding: If we keep adding the same monthly increase to a price index, the year-to-year change must keep moving higher. And adding more low-inflation months won't be enough to change the 12-month average's inertia.
However, one particularly important price, big jumps in the worldwide price of crude oil, has always shown to be transitory (temporary) in the past. "Year to year percentage variations in the CPI... inevitably go up and down with year to year percentage changes in the price of oil," I wrote last month. Non-energy costs such as transportation and energy-intensive items rise when oil prices rise.
Is the producer pricing index (PPI) the same way? Yes, in a nutshell.
The Wall Street Journal writes, “The Labor Department [reported] that its producer‐price index rose 9.6% in November from a year earlier, the most since records began in 2010.” On the contrary, most PPI records began in 2013. It is only the “final demand” PPI—the short blue line in the graph below—that has such a brief history.
A dotted black PPI line for all commodities is also included on the graph, as well as a green line that eliminates services but includes just final demand for "finished products minus food and energy." Because energy influences the cost of transportation services and several energy-intensive items, the green line for "core" commodities is also closely associated with oil and energy prices.
If we omit energy costs, any 12-month average for the PPI for consumer goods must be ambiguous, as numerous monthly price movements have been negative since 2020. The final demand PPI for consumer goods less energy fell 6.2% in February 2020, then rose 32.1% in May before falling 19.8% last June, 7.1% in December, and 3.6% this July.
Any Producer Price Index measures prices received rather than prices paid. It tracks the prices that firms in the United States paid for over 3700 items and 800 services. Since 1978, it has not been referred to as a "wholesale pricing index," and it has never tracked price fluctuations in the wholesale market. It's also not a measure of company costs, because a greater cost for one business client typically means more income for another. Governments and international importers, not only American firms and consumers, pay producer prices.
October’s headline 0.6% rise of the final demand PPI (0.3% excluding energy) included a huge 10.2% monthly rise in energy prices for export, which reflected soaring Asian demand for coal and European demand for natural gas. Higher export prices improve the terms of trade: Americans get more for less.
Since producer prices are paid not just paid by Americans or consumers, among many other reasons, the PPI is not comparable to the CPI (and certainly not a leading indicator of some future CPI). Yet the Journal speculates that, “higher‐than‐expected producer‐price numbers suggest that consumer inflation… will stay elevated into 2022.” On the contrary, evidence suggests the PPI cannot predict the CPI.
Significant spikes in year-to-year rises in producer prices for commodities (including core commodities) have frequently been dominated by big spikes in year-to-year increases in crude oil prices, as seen in the graph. What 2021 has in common with 1974, 1979, 1990, and 2008 is that each of those years saw the worldwide price of crude oil approximately double on a year-to-year basis. Almost everyone assumed it was part of an ever-increasing inflation that would never cease unless and until someone took serious action. But, even on a sluggish year-to-year basis, when oil prices stopped rising—or plummeted in 1991, 2001, and 2009—inflation statistics suddenly decreased.
The price of West Texas Intermediate (WTI) crude oil quintupled from $16.55 a barrel in April 2020 to $81.48 a barrel in October 2021, directly and indirectly raising the PPI and CPI. WTI crude oil, on the other hand, has fallen from a projected top above $85 in late October to below $70 in early December. The year-to-year PPI and CPI in the United States might reduce dramatically by the Spring of 2022, when the low 2020 base effect would gone, assuming oil prices stabilize or fall.
In summary, previous oil price surges have resulted in frightening year-over-year inflation figures, as they did this year. Past oil price surges, on the other hand, have seldom lasted long since they dampen demand while increasing supply, as seen in the table. Year-over-year PPI jumps of 6–20 percent during six prior oil surges were followed by substantially lower inflation rates the next month—including declining prices (deflation) in two of the six occurrences.
Unfortunately, because oil price spikes have been mistaken for long-term inflation tendencies, they have occasionally resulted in recessions when the Federal Reserve overreacted by raising short-term interest rates above long-term interest rates.