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July 15, 2011
Core Training: Measure of Inflation
By Cindy Ivanac-Lillig
I recently spoke at a university and when we came to the slide on core inflation, someone sighed (loudly). That’s because folks bristle at the idea of core inflation (inflation measures that strip out food and energy costs). It is like going to a doctor and saying that your arm is broken and infected and the doctor responding, "Well outside of your extremities, the core of your body looks perfectly healthy." Nothing to worry about... right?
If folks are paying substantially more at the grocery store and the gas pump, they won't enjoy being told that what the Fed and other policy makers care about is the cost of everything except food and energy.
It is not that the core measure is better than the headline (or overall) measure. They are just indices designed for different uses. For example, if you are interested in assessing what inflation is for the average consumer today, the headline numbers are the way to go. After all, these numbers give you a snapshot of how things are actually going in terms of our total expenditures. However, if you are responsible for policy development, you may like to know in addition to the snapshot, how telling these numbers are for what is coming down the pike. And this is where core comes into play. Many economists believe that the core has better predictive value. The notion is that by removing the more volatile items, such as food and energy, you would be left with a clearer picture -- not of today's reality but of future inflation. There are even leaner measures than traditional core measures that try to pare down even further to get to some underlying inflation signals. For example, the Dallas Fed puts out a Trimmed Mean PCE Inflation Rate.
Inflation is an interesting and dynamic topic. There are folks arguing that core should be further pared down by subtracting some additional categories that have proven to be volatile and those on the other side arguing that core is not the best way to think about future inflation to begin with.
What do you think?
For current Personal Consumption Expenditure (PCE) information, check out BEA.
(Note: The Fed prefers the Personal Consumption Expenditure (PCE) measure of inflation over the more well-known Consumer's Price Index (CPI). Both of these indices assess how much more or less it is costing people to buy what they normally buy. And both track each other fairly well. The PCE is put out by the Bureau of Economic Analysis, and unlike the CPI, accounts for consumers substituting goods as prices change. There are a few other technical differences on how things are weighted and accounted for. Here is a presentation that compares the two measures.)
Posted by Cindy at July 15, 2011 10:20 PM
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Comments
The core inflation rate has predictive value for policy, but does not translate well into "real life." It is like someone saying,"If I don't see it, it's not illegal."
I believe what the policy makers need is a measurement that smooths out volatility rather than disregard it completely, for example: a food average over a few quarters; and an energy price average over a longer term, these would provide a starting point at which monthly measurement could be calculated. If the food price was assigned an average over the last five quarters and the current quarter prices fell below that average, then the average will be pulled down by the lower rate.
The measurements would incorporate the monthly changes to a consumer's spending while factoring out some volatility.
Posted by: Nico Caputo at July 27, 2011 4:57 AM
Thanks for your comment. It is really interesting. Many have said that some type of moving average may have the same value as a core measurement. Looking forward to the continued work on the topic.
Posted by: Cindy at July 27, 2011 5:29 PM
Going to put this atrilce to good use now.
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Posted by: Gregg Strater at June 11, 2012 10:04 PM
Inflation is not a concern at this time. Bernanke suhold think about boosting the economy. Japan is the example of what happens when a central bank gets too fussy about inflation. Wow. So many errors in so few words. Congratulations, if there were an ignorance contest you would be among the leaders. First, inflation is a concern. The USD has lost more than 80% in the three decades since Nixon defaulted by closing the gold window. Second, it is not Bernanke\'s job to boost the economy. He is supposed to keep the purchasing power of workers and savers from falling. Third, Japan was never concerned about inflation. It borrowed and spent with the best of them. The problem is that you can\'t correct a balance sheet recession by borrowing and spending. Forth, Japan owed most of its debt to its citizens and ran strong trade surpluses. It had more leeway and more time to do its damage. The US is dependent on external financing of it debt and deficits and has little leeway.
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