Not all price increases are equal; pandemic-era outliers drove inflation spike

Many individual price changes make up widely used gauges of inflation. Their relative importance changes over time and may affect how consumers perceive inflation.

Commonly known as the CPI, the Consumer Price Index All Urban Consumers is a monthly measure of U.S. inflation. Headline CPI, which includes often-volatile food and energy prices, provides the broadest view of inflation. Its recent peak was at an annual rate of almost 9 percent in June 2022.

In the wake of the pandemic, more of the CPI’s component prices gravitated sharply higher, bringing the overall inflation rate up with them. The larger share and composition of components experiencing these outsized price increases may have damped consumer sentiment. Recent evidence, however, indicates normalizing price conditions.

Constructing the CPI

The CPI aims to capture changes in the prices of a representative basket of goods and services consumed by urban consumers. Each month, the Bureau of Labor Statistics (BLS), which constructs the CPI, records the prices of 243 categories of goods and services (components) across the U.S. Following these prices over time, a price series for each CPI component is generated by averaging all the prices falling into that bucket.

The BLS also administers the Consumer Expenditure Surveys to derive the weights of the CPI components, indicating items that are more or less central to consumer expenditures. Thus, the final headline CPI index is a weighted average of all the various CPI component price series.

Although quite comprehensive, the CPI is prone to error. Potential sources of error include the selection of outlets where the BLS records prices, definition of regions and determination of weights.

The weights are not updated with each release of the CPI, so consumer substitution to less expensive goods and services that occurs in response to price increases is not directly captured, causing the CPI to overstate the true rate of inflation.

For this reason, the BLS also produces a chained version of the CPI whose methodology is less prone to this substitution bias. Separately, the Federal Reserve defines price stability in terms of the inflation rate for the personal consumption expenditures price index, another inflation measure that is also less prone to substitution bias.

Different methods of aggregation reveal underlying price behavior

The month-to-month movements of the various CPI components are rarely identical. The direction and magnitude of these movements are extremely variable. To understand how the changes in different CPI components relate over time, we examine the 120 seasonally adjusted CPI components since January 2000, by calculating central tendencies and descriptive statistics for each month.

The difference between the unweighted mean and unweighted median of the 12-month inflation rates of the individual CPI component prices indicates which side of the distribution (high inflation or low inflation) may contain outliers or a more-than-usual share of the individual prices.

If the mean is above the median, more than half of the individual prices are increasing at a slower rate than the mean. In other words, if the mean is higher than the median, a small number of prices are increasing very fast or well above the median.

We observe something like this during the pandemic-era inflation (Chart 1). Through the pandemic, most CPI components increased at a slower pace than the mean CPI component.

Moreover, the mean CPI component increased faster than the published aggregate (headline CPI) through the pandemic, implying the “less important” CPI components (that is, those with smaller expenditure shares or weights) were often the ones driving the unweighted mean higher. These relationships have flipped in recent months, with headline CPI notably higher than both the mean and median.

Moreover, the maximum CPI component—the price series experiencing the greatest increase each month—massively spiked during the period of pandemic-era inflation (Chart 2). At the same time, the minimum CPI component—the price series experiencing the smallest increase or largest decrease—fell but not outside the historically typical range.

The 90th and 10th percentiles of the CPI components both increased through the pandemic-era inflation in a way that tracks the headline CPI. Since these two series similarly moved higher, most of the CPI components moved together, while some of the very tail-end extremes defied the trend.

Considering the unweighted shares of CPI components increasing at a faster than 10 percent annual rate and those increasing at a less than 1 percent annual rate (including those decreasing), demonstrates which parts of the CPI component distribution contained most of the components over time.

The share of CPI components rising faster than 10 percent annually increases during the pandemic-era inflation. Simultaneously, the share of CPI components rising at less than a 1 percent annual rate decreased, and the share of CPI components increasing between a 1 and 10 percent annual rate remained stable (Chart 3). This indicates that the expansion of the right tail (components with large price increases) drove inflation higher.

Interestingly, the tail-end shares even at their pandemic-era respective peak and trough were in a range not too different from that of before the Global Financial Crisis.

What does this mean going forward?

High perceived inflation can prompt households to update their inflation expectations, decreasing optimism about real economic activity. The CPI for gasoline was often the maximum or close to it through the pandemic-era inflation. Gasoline is one of the more visible prices to urban consumers because it is frequently purchased, and its prices are widely displayed.

Dramatic increases in the prices of goods that are frequently purchased can negatively affect consumer sentiment above and beyond what high inflation alone could do. During the pandemic-era inflation spike, prices for many food basics—eggs, for example—dramatically increased, further weighing on consumer sentiment.

Other CPI components—car rentals and airfares—experienced extreme price increases, but consumers do not interact with these as frequently, making the link to consumer sentiment more challenging.

Most of the distributional measures of inflation have either returned to prepandemic levels or are trending in that direction.

However, the share of CPI components increasing at an annual rate exceeding 10 percent or below 1 percent appear to be settling at levels between those that preceded the Global Financial Crisis and those that occurred during the decade spanning from the financial crisis to the pandemic.

More recently, from December 2023 through February 2024 , 26.1 percent of CPI components increased at a rate exceeding 10 percent. By comparison, that share was 37.1 percent before the Global Financial Crisis and 19.6 percent in the decade before the pandemic. This indicates that inflation—while perhaps not as steady as it was throughout most of the 2010s—should remain consistent with overall price stability during the two prepandemic periods.

Even if price volatility continues, with a higher share of prices increasing quickly, it remains possible that the remaining components will balance out the overall CPI, making it possible to achieve 2 percent aggregate inflation, in line with the Fed’s target.