Do Oil and the Dollar Affect Core Inflation?

Over the past year, the already-low rate of inflation has been handed additional challenges from the plunge in oil prices and a strengthening dollar. According to the minutes of the Federal Open Market Committee’s (FOMC) March meeting, recent below-target readings of inflation were “largely reflecting declines in energy prices and lower prices of non-oil imports.” Fed officials have frequently emphasized that these forces are likely to affect inflation only temporarily. As is customary when prices are affected by transitory factors, attention shifts from headline to core inflation readings. But how sensitive is core inflation to the decline in oil prices and the higher value of the dollar over the past year? 

Core inflation has remained relatively steady over the past year, even as headline inflation has plunged (Figure 1). After dipping to 1.6 percent in January, the 12-month change in core CPI has moved back to 1.8 percent. The Fed’s preferred measure of core inflation, the PCE deflator, has also begun to bounce back after a short period of disinflation around the start of the year (Figure 2). Even with some recent improvement, both measures continue to indicate the Fed has some ways to go before inflation reaches more desirable levels. Would core inflation be nearer the Fed’s implied 2 percent target without this past year’s drop in oil prices or strengthening of the dollar? We do not find much empirical support to the notion that the decline in oil prices and the stronger dollar have pushed the core rate of inflation lower. At best, there is only a very small link between core inflation and the price of oil or value of the dollar.