Divergent Sources of Inflation

February 23, 2011

As commodity prices around the globe continue their steady march upward, convention would suggest that inflation in the U.S. isn’t far behind. However, as many developing nations have already felt the sting of rising costs, inflation in the U.S. remains largely absent. Headline CPI rose only 1.6% in December over the previous year despite surging costs for oil, gold, cotton and many other commodities.

The cause for the divergence is a split between the pace of increases in the prices of goods and those for services. Producers, largely unable to absorb further increases in input costs, have begun to signal to consumers that price increases are inevitable. Thus the red line on the graph, which represents the cost of goods, has recently risen and is above its long term average, therefore adding inflationary pressure to the economy. Goods included in this metric include commodities and non-durables, less food and beverages. Meanwhile, the costs for many services (such as rent, electricity, and medical care) in the U.S. have grown at a much slower pace since the beginning of the crisis as high unemployment has stifled wage growth. The cost of services is shown by the blue line on the graph; the most recent values sit well below the long term average, therefore lessening inflationary pressure on the economy. At the end of January, inflation for goods registered an increase of 2.2% over the previous year while prices for services only advanced 1.2%. On average over the past 20 years, prices for services have grown 1.75 times faster than those for goods, but cheap labor from developing nations has kept prices for goods in check. So while rising commodity prices can be a driver of inflation here in the U.S., it will likely take acceleration in the prices of services before headline inflation can take off.