Thread by @jasonfurman

When you look at this picture are you comforted about the future trajectory of inflation or scared?

Most people are comforted--they picture goods inflation falling while services inflation stays the same.

But what if the shift from goods to services raises services inflation?

Some facts on durable goods vs. services in the CPI:

Overall weight:
Services: 61%
Durables: 12%

Core CPI weight:
Services (less energy): 74%
Durables: 15%

So a 1pp increase in services inflation is enough to offset a 5pp decrease in goods inflation.

The US has increased a huge increase in inflation-adjusted spending on goods. This spending has come down a little but remains high. At the same services spending has been recovering slowly and remains well below trend. See earlier thread for more.

https://twitter.com/jasonfurman/status/1463540781189324812?s=20

It is widely expected that spending on goods will decline (although it has stayed higher than many people, myself included, expected. I would have thought everyone had enough toys/musical instruments/sports equipment etc. by now).

That should take pressure off goods prices.

But the flip side is that services spending is likely to rise which will put upward pressure on services prices. Some of those prices are notably low, like pandemic-associated services.

And then there is rent and owner's equivalent rent (OER). This will rise with near certainty because we know rent on new leases rising rapidly and the BLS methodology only slowly updates to true rents. Moreover is 3X the weight of durables in the CPI.

(Note the Federal Reserve targets another measure of inflation, the Personal Consumption Expenditures price index, which has a lower weight for shelter. It has not been rising nearly as fast as the CPI lately at that divergence is likely to persist as rent/OER/shelter rises).

Ultimately this comes back to the micro-macro distinction in inflation analysis. You can't just assume everything with unusually large price increases returns to normal while everything with slower increases stays that way.

https://twitter.com/jasonfurman/status/1458886062890270720?s=20

My own guess is the pace of core inflation will indeed moderate some in 2022 relative to 2021 (and overall inflation will moderate even more). But it isn't obvious and I would not expect a lot of moderation. Rough guess is core PCE and core CPI in the 3-4 percent range for 2022.

P.S. some of the above comes back to the question of what is more inelastic (i.e., need a large price increase to elicit more quantity supplied), the durable goods or services. The answer is not obvious given that the supply of goods is global and services are labor intensive.