Given the practical ambiguities in modeling inflation using the Phillips curve, an alternative is to separately analyze each component of CPI. Our approach allows a large degree of modeling heterogeneity across the prices of different goods and services without requiring an explanation of the dynamics within a unique framework.
To use this approach, we disaggregate core inflation from headline inflation, isolating the more volatile CPI subindices of food and energy, which currently represent about 14% and 7%, respectively, of the headline index. Oil’s collapse from about $105 a barrel in mid-2014 to approximately $35 in early March 2016 has been the predominant driver of energy inflation, which fell almost 13% over 2015. Given its importance in the aggregate index, this drop translates into about a full percentage point being subtracted from headline inflation. Food inflation has also been below average, partially due to a strengthening U.S. dollar and cheaper oil, the latter implying, among other things, lower transportation and packaging costs.
The annual inflation rate of core goods and services, which account for about 19% and 59%, respectively, of headline CPI, offer a blurrier picture, as Figure 5 illustrates. Different dynamics impact these two indices. Goods inflation is closely related to the global economy and to the path of the U.S. dollar because globalization has led to greater foreign competition for U.S. manufacturers. In contrast, services inflation is closely related to the housing market and to the national economy, characterized by lower substitutability of the labor force.