The FOMC most recently stated its inflation goals in this document. In particular,
...inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate. The Committee would be concerned if inflation were running persistently above or below this objective.That concern is reflected in the last FOMC statement:
In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal.So, apparently, inflation (according to the FOMC's chosen measure, the raw pce deflator) is moving toward the 2% goal, and for those who care about core inflation measures, the same thing is happening.
But what if we measure inflation in different ways, just to check. The next chart shows average inflation, for both the raw pce and core pce, calculated over the last month, the last two months, etc. That is, "months" on the horizontal axis is the number of previous months over which we're calculating the average inflation rate:
Next, let's look at the components - here we'll look at the CPI components, as that's more convenient. The large price increases in the recent data are coming mainly from non-energy services:
Shelter prices are a bit unusual in the way they are measured and incorporated in the CPI, and in the pce deflator. In particular, in the CPI about 2/3 of the weight in the shelter price is accounted for by imputed rent of ownership housing. The idea is that, implicitly, you rent your house from yourself, and the price of the services you are receiving is measured as the rent that you would pay to a landlord for a similar dwelling in the rental market. In terms of the distortions that might be caused by inflation, this seems odd as, for the most part, there are no transactions associated with most of the existing housing stock - only a small fraction of the stock turns over in a given year. Further, what is being counted in these price indexes is some shadow price of a non-market service. If we're going to count imputed rent on ownership housing in our inflation measure, why don't we count imputed rent on my refrigerator, the shadow price of the dishwashing services I'm supplying, etc? Go figure.
Just for good measure, let's look at the prices we're dropping when we measure core inflation. Here's food:
1. Surely policymakers are smart enough to make judgments about which movements in inflation are due to temporary non-monetary factors, and which are not.
2. Large movements in the relative prices of food and energy can be highly persistent.
3. People might be tempted to think that, if food and energy prices had behaved in different ways, that core prices would have behaved in the same way they actually did. That can't be true.
4. Stripping out food and energy means putting even more weight on the price of shelter, which we know doesn't reflect actual transactions prices, for the most part.
To expand on the third point, if energy prices had not fallen dramatically, then holding constant nominal incomes (possibly not a great assumption, but what the heck), consumers would have had less to spend on other goods and services, and those other prices would be lower than they actually are.
So, what's going to happen to prices in the future? So far we're not yet seeing any turnaround in the raw pce inflation measure - as we showed above the increase in 12-month inflation is just a quirk in the data. But since the price of crude oil has started to increase again, if the prices of services continue to increase at 3% or more, we will indeed see raw pce inflation start approaching 2%. But that's just it. There's no good reason to think that, if energy price inflation increases, other components of inflation won't decrease.