Last Friday, the Commerce Department released its monthly update on personal income and spending, and as it does every month, the latest release, covering February, includes data on a key measure of inflation that’s closely watched by the Fed: the Personal Consumption Expenditures (PCE) price index, both in its overall “headline” version and an array of variants.
Over the past two years, we’ve gotten used to hearing about record-breaking inflation readings; last June, for example, the Consumer Price Index rose at its fastest twelve-month rate — 8.9 percent — since the peak of the 1970s–early 1980s inflation wave that was finally brought to an end by former Fed chair Paul Volcker’s brutal reign of tight money.
But this month’s record is a little different.
Traditionally. the Fed has paid closest attention to so-called “core PCE,” a version of the index that strips out food and energy prices, because those volatile categories tend to inject a big dose of noise into the numbers.
But over the past year, another category, housing, has also gained notice as a distorting factor. That’s because the methodology used by government statisticians measures the trend of residential rents with a fairly long lag, since leases normally freeze rates for the duration of a contract, typically twelve months.
According to recent research by the Federal Reserve Bank of Cleveland, if the trend of rents is measured using only newly signed leases (a more timely indicator of price pressures), rental inflation fell dramatically in the third quarter of last year, the most recent period for which the Cleveland researchers have calculated the numbers; but because of the aforementioned lag, the shift has not yet fully appeared in the housing component of official price indexes like PCE. This obviously distorts the inflation data, and the unusually large gap between actual and measured rent that currently prevails is expected to continue for the rest of this year.
To get a more reliable gauge of the underlying pace of inflation, it therefore makes sense to remove housing from the Fed’s preferred core PCE index, leaving us with a measure I’ll call nonhousing core PCE.
When we look at that metric, we see that February’s numbers indeed set a record: the twelve-month period that ended in February saw the biggest decline in inflation, relative to the preceding twelve months, of any period since the Volcker disinflation of the early 1980s. In other words, if we take the nearly five hundred months since the 1982 trough of the Volcker disinflation and rank them by the decline (or increase) of twelve-month inflation, February 2023 literally comes in at number one.
And lest there be any suspicion that this is just a quirk of the data, note that exactly the same record was set by February’s Consumer Price Index, which was released by the Bureau of Labor Statistics a little over two week ago: the drop in nonshelter core inflation was the biggest since the early ’80s.
Meanwhile, the rate of deceleration in wage growth — as measured by average hourly earnings for production and nonsupervisory workers — has been flirting with a similar record: the January and February declines in twelve-month wage growth were the fourth and sixth largest since the Volcker disinflation (and three of the other top months were associated with the COVID-19 shutdowns of spring 2020).
Looking at the breakneck disinflation pictured in the chart above, it’s worth recalling Larry Summers’s long-standing prediction that post-COVID inflation would never come down without a large increase in the unemployment rate engineered by aggressive Fed rate hikes. Those rate hikes eventually arrived, and higher unemployment is likely to follow — but neither it, nor Summers, should get the credit for inflation’s retreat.