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The November Consumer Price Index came in lower than most analysts, including me, expected. The year-over-year (YOY) rate in the overall index was 2.7 percent, while it was just 2.6 percent in the core index. Most of us were expecting increases in both indexes close to 3.0 percent.

While the drop in the inflation rate was surprising, there may be less here than meets the eye. A big part of the drop was a sharp decline in the reported rate of inflation in the rent index and the owners’ equivalent rent (OER) index. Their YOY rates came in at 3.0 percent and 3.4 percent, respectively. This is down from reported rates of 3.4 percent and 3.8 percent for September.

To have this sharp of a decline in the rental indexes, rental inflation would have had to been extremely low in October and November. The average inflation rate for these two months would have had to have been 0.006 percent for the rent index and 0.014 for the OER index. 

This sort of sharp drop in the inflation rate in these indexes is implausible. Omair Sharif speculates that they have effectively zeroed out rental inflation for October, causing the CPI to understate the YOY rate of inflation in these indexes. 

A very crude adjustment would double the average rental inflation for the two indexes, adding 0.006 pp to YOY rental index and 0.014 pp to the OER index. That would have been enough to increase the measured inflation rates in both indexes by 0.01 percentage points after rounding to 2.8 percent overall and 2.7 percent in the core index. That would still be a considerably better reading than had been expected.

Another possible source of understatement is a limited collection of health insurance data. The health insurance component, which measures only the administrative costs and profits of insurers, fell from showing a 4.2 percent YOY rate of inflation in September to a 0.6 percent YOY rate of inflation in November. 

In order for the year-over-year rate to have fallen that sharply, the monthly inflation rate in health insurance index would have had to average -1.4 percent in October and November. That does not seem likely. If the actual YOY inflation rate in the health insurance index was 3.6 percent (roughly its average over the last year), it would add 0.024 pp to overall index and 0.03 pp to the core index, taking the YOY increase in the overall index to 2.82 percent and 2.73 percent in the core index.   

The third possible source of understatement in the November CPI resulting from shutdown stems from the fact that prices were only collected in the second half of November (after November 14th), due to the shutdown. This matters because stores often put products on sale for the holiday season. If most of these sales only take effect in the second half of the month, as it gets near Thanksgiving, the prices collected in the second half would understate the average prices for the whole month.

There is reason to believe this sale effect could be substantial. In the last three years, the seasonally adjusted rate of inflation for non-food commodities from October to November averaged 1.0 percentage points more than the unadjusted inflation rate. This means that a drop in price of roughly 1.0 percent from October to November is expected due to normal seasonal effects.

The November CPI showed the seasonally adjusted rate of inflation in non-food commodities averaged just 0.07 percent for October and November. The average monthly inflation for the six months from April, after the tariffs were first announced, to September was 0.27 percent. 

If the actual rate of inflation over this period was the same as this average for the prior 6 months but was biased downward by the limited data collection period, then the YOY rate in the index for non-food commodities could be 0.4 pp higher than what was reported today. That would add a bit less than 0.1 pp to the overall CPI and a bit more than 0.1 pp to the core index.  

Together with the adjustments for the rent calculations and the health insurance indexes, this would get the YOY CPI in both indexes to roughly 2.9 percent. These calculations are obviously speculative, although the measure of rental inflation seems to pretty clearly result from a mistaken formula. 

In any case, there are good reasons for believing the inflation story may not be as positive as the November CPI indicates, but we will have to wait until next month to know for sure. (The rental index problem will still be there until April, unless they change the formula.) 

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