In a commentary last week entitled “Jobs and Prices” (https://www.cumber.com/market-commentary/jobs-and-prices), some estimates were provided as to what we might expect the August CPI number to look like based upon some simple linear equations that attempted to capture the pass-through from the PPI. As many are well aware, predicting economic outcomes is not unlike predicting the paths for hurricanes.
There is a range of potential paths for a storm, and it is common to see so-called spaghetti plots showing what is possible. The key is whether the actual path tracks within the plots or outside the range of plots. The same analogy holds for forecasting economic variables. For any given model there is not just one possible outcome but a range of outcomes which are all consistent with the model. Last week’s forecasts for PCE and CPI are no exception.
Using the current PPI, which was up 0.7%, and the previous two months, which were both up 1.0%, as independent predictors, we estimated that the CPI would be up about 0.5%. What was not presented was the range of possible outcomes. The actual number turned out to be 0.3%. So, was that number within the range of possible outcomes or not?
It turns out that we can estimate with 95% confidence, for example, that the true number being forecast lies within a particular range. Using our model, given that the August value of PPI growth was 0.7% and the previous two months’ values were both 1.0%, we could with 95% confidence, be sure that the reported CPI would turn out to be between 0.3% and 0.79%. Thus the number reported by the BLS of 0.3% was, in fact, right at the bottom of the probable paths for the CPI, which were actually quite wide. The lesson here is not to put too much weight on a particular number but rather to be mindful that a wide range of outcomes are all possible, and how closely estimates align with outcomes depends upon the precision and quality of the underlying model providing the estimates. One thing is clear, however, and that is increases in producer prices don’t get 100% passed on in the form of similar increases in consumer prices.
Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.
