The Dollar Can Really Nickel and Dime You on Inflation

Changes in the value of the U.S. dollar have ripple effects that are felt throughout the economy; this paper builds on past work our group has done examining the dollar’s effect on prices. From its cycle high in December of 2016 through to the end of 2017, the trade-weighted value of the U.S. dollar shed more than 10 percent of its value. Global currency markets have had a choppy start thus far in 2018 as well, not unlike financial markets, but the dollar’s decline has continued losing another 1.2 percent of its value so far this year and our currency strategy team anticipates a continued decline of roughly 2-3 percent in the value of the dollar against a basket of the currencies of our major trading partners throughout 2018 (Figure 1).

During other periods of dollar volatility throughout the current cycle, our group has done some work trying to explain the implications of dollar movement for different aspects of consumer inflation here in the United States.1 In this piece we build on that work to gauge the extent to which dollar valuation influences broad categories of inflation: commodities, core goods and core services. We find that the value of the dollar is very important in understanding commodity prices, somewhat important when thinking about core consumer goods prices, and (perhaps intuitively) not terribly influential when it comes to pricing in the service sector.

Academic economic exercises often come with a “ceteris paribus” qualifier, meaning “all else equal” or “with other conditions remaining the same.” In practical application, of course, decision makers cannot hold other conditions the same, so we attempt to provide some real-world guidance as well.

Oil Flows and Oil Prices Flow-Through

Moves in the value of the dollar have been closely tied to changes in commodity prices. As illustrated in Figure 2, there is a strong, negative correlation between the trade-weighted value of the dollar and Bloomberg commodity index (-0.60 between 1993 and 2017). The dollar and commodity prices tend to move opposite directions due to most commodity contracts being priced in dollars. Changes in the dollar need to reflect fluctuations in the purchasing power of other currencies. As the dollar weakens, it costs less of a foreign currency to purchase the same amount of a commodity. The relationship is reasonably strong for energy (-0.32) and food-related commodities (-0.43).

While consumers are not buying barrels of oil and bushels of wheat, they are purchasing refined energy products and processed/prepared foods which all start as “raw commodities.” It doesn’t take long for changes in oil prices to affect what consumers pay at the pump (Figure 3). The CPI energy index rises 20 basis points for every one percent rise in oil prices (both measured year-over-year).2

There is also a flow-through to what consumers pay for food, but it lags. A 1 percent increase in the Commodity Research Bureau (CRB) food index over a given year raises the year-over-year rate of CPI food inflation by 6 basis points with about a six-month lag. 3 That might not sound like a lot, but agricultural commodity prices are given to pronounced price swing of more than 1o percent a year, so even 6 basis points can quickly become more than half a percentage point of food inflation (Figure 4). If the pass-through here feels small, it may have to do with the fact that roughly half of CPI food inflation is “away from home” and thus it is as much a measure of service costs as it is of the food itself.

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