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short essays and reports on the economic issues of the day
2006 ■ Number 2

Gauging the Size of Today’s Price Shocks
Kevin L. Kliesen
arket-based economies operate best when consumers
and producers are not routinely surprised by changes
in the price level. Sometimes, price level surprises
(shocks) are the unavoidable result of large changes in relative
prices that are unanticipated—and energy price hikes are a
notable example. Although monetary policy probably has no
direct, short-run effect on energy prices, the central bank can
help prevent the transmission of such shocks into the rate of
ongoing, trend inflation and inflation expectations.
One simple measure of price shocks is the difference
between total and core inflation, per Mankiw.1 Over long
periods of time, total and core inflation are roughly equal
because shocks average approximately to zero—i.e., increases
and decreases tend to cancel each other out. An important
problem for monetary policy is whether such shocks increase
core inflation (a proxy for ongoing, trend inflation) or whether
inflation expectations are well-anchored by a credible antiinflation monetary policy.
Since the fourth quarter of 2002, total inflation (i.e., the
four-quarter percent change in the price index for personal
consumption expenditures, PCE) has regularly exceeded core
inflation—largely due to the behavior of energy prices. The
table compares price shocks in the past few years with those
in the 1970s, also a period of unusually large increases in
energy prices. That period is often referred to as the Great
Inflation. For comparison, the dates most often associated
with changes in the trend rate of labor productivity growth—
1973 and 1995—will be used as breakpoints.2
From 1960 to 1972, average rates of PCE and core PCE
inflation were roughly equal. Although the average price
shock was slightly negative, its standard deviation was about
0.3 percentage points. The worst shock occurred in 1966:Q1,
when PCE inflation was 0.64 percentage points more than
core PCE inflation. From 1973 to 1995, the relative price of oil
experienced major hikes and declines. Although the average
shock was only about 0.1 percentage points, its standard deviation was more than 1 percentage point per quarter (the worst
shock, in 1974:Q1, was more than 3.5 percent). Not only was
inflation high and variable, but food and energy price increases
infiltrated measures of core prices more readily than before.


Interestingly, since 1996 the average price shock has
increased to about 0.25 percentage, but its standard deviation
has dropped by more than half (0.48 percentage points). If we
focus solely on the 2002-05 period of sharp oil price increases,
the average price shock has increased slightly more, with the
largest being 1.15 percentage points (2005:Q3). Indeed, since
2002 the average price shock, 0.37 percentage points, is three
times larger than the average from 1973 to 1995. Central
bankers can take some solace in the fact that the volatility of
price shocks has not increased since 2002. Moreover, the standard deviation and the size of the worst price shock have both
been about a third as large as those during the 1973-95 period.
Large and persistent increases in energy prices over the
past few years have produced sizable price shocks. However,
their volatility has been substantially less than that during the
Great Inflation. Moreover, these price shocks do not appear to
have elevated inflation expectations, as measured by surveys,
long-run forecasts, or yield spreads between nominal and
inflation-indexed Treasury securities. This finding suggests
that today’s monetary policymakers have been successful in
achieving and maintaining a degree of credibility that was
not apparent in the earlier period. ■

N. Gregory Mankiw, “U.S. Monetary Policy During the 1990s,” in Frankel and
Orszag, eds., American Economic Policy in the 1990s. Cambridge, MA: MIT Press,


The core PCE price index begins in 1959.

Food and Energy Price Shocks, Various Periods









Std. dev.










NOTE: Price shocks are defined as the four-quarter growth of the chainweighted PCE price index less the four-quarter growth of the same
index that excludes food and energy prices.
SOURCE: Author’s calculations.

Views expressed do not necessarily reflect official positions of the Federal Reserve System.