Why It's Important to Consider Volatility of Prices When Thinking About Measuring the Rate of Inflation--In One Graph

When we teach introductory macroeconomics, we frequently talk about the importance of trying to keep in mind that some prices are (much) more volatile than are others.  Indeed, the Bureau of Labor Statistics publishes what is often called the "core" CPI measure of the rate of inflation, based on the CPI excluding energy and food prices.  But it can be hard for people to "get" why excluding extremely volatile prices can be important.

Here's one graph that, I think, does it.  The black line is the 12-month percentage rate of change in the CPI (all goods, including gasoline) and the 12-month percentage rate of change in the price of gasoline.

 



(Click to enlarge.)

Keep in mind that the price of gasoline is included in the CPI, so the increases or decreases in gasoline prices are already a part of the rate of inflation as measured by the CPI.  Also, by using 12-month rates of change, rather than monthly rates of change, I have already damped somewhat the volatility of gasoline prices.  (The monthly percentage changes are something to behold...)

And it's true that during the 1967 to 2014 period gasoline prices increased at a faster annual average rate (5.3%) than did prices in general (4.3%), it's also true that the extraordinary volatility of gasoline price changes would give us, by themselves, a misleading idea of that is going on.

(Data from FRED.)