Economists are sometimes accused, and justly so, of trying to read too much into the latest monthly wiggle in every data series that they watch. To counter that tendency, we can start the discussion of today's release of inflation data with a longer-term view. Instead of looking at monthly CPI data, let's look at five-year averages. As the following chart shows, five-year inflation has fallen to an annual rate of just 1.9%, its lowest since the Vietnam War started heating things up in the 1960s.
The main monthly and annual indicators were also well-behaved in December. A decrease in gasoline prices left the headline CPI unchanged for the month, and up just 1.7% from its December 2011 level. Year-on-year inflation for 2011 was a full percentage point higher, at 2.6%. Core inflation, including food and energy prices, was also moderate, up just 0.1% for the month and 1.9% for the full year.
Looking ahead, markets expect continued calm on the inflation front. As I noted in a post last week, 10-year inflation expectations, as measured by the Cleveland Fed, have been hovering near record lows. One might think that lower expected inflation would mean an increased probability of deflation, but that does not appear to be the case, at least not as measured by the Atlanta Fed. Their latest estimate shows just a 6% probability that the CPI for April 2017 will be lower than the CPI for April 2012. That is 10 percentage points below the peak estimate of deflation risk reached in the middle of last year.
In a speech yesterday, Minneapolis Fed President Narayana Kocherlatoka urged the Fed to worry less about inflation and more about unemployment, using the following language:
Under current policy, my outlook for inflation is that it will run below the Fed's target of 2% over the next two years and that the unemployment rate will be above 7% over that same period. Hence, the FOMC can better promote price stability and promote maximum employment, as mandated by Congress, by adopting a more accommodative policy stance. It can provide that extra accommodation by lowering the unemployment rate threshold in its forward guidance to 5.5% from the current setting of 6.5%.
The latest inflation provide additional support for that view.