Looking behind the core inflation numbers
What’s at stake: The prices of US goods and services, excluding food and fuel, fell last month for the first time since 1982. Headline inflation in January remained stable from the previous month at a 2 percent annual rate, a bit above most private forecasts, boosted by higher fuel costs. But the show was stolen […]
What’s at stake: The prices of US goods and services, excluding food and fuel, fell last month for the first time since 1982. Headline inflation in January remained stable from the previous month at a 2 percent annual rate, a bit above most private forecasts, boosted by higher fuel costs. But the show was stolen by the core measure. Excluding food and energy, consumer inflation saw the largest monthly drop in more than 27 years and its third largest decline in 47 years.
Laurel Graefe for the Atlanta Fed’s macroblog writes that several factors were behind the decline in the core index (such as falling airline fares, a dip in new car prices, and ongoing declines in prices for household furnishings and operations), but a sizeable drop in shelter prices, which account for more than 40 percent of the core CPI index, was a significant factor in January’s dip. A concern that decelerating shelter prices could skew the core inflation measure down was noted in the minutes of January’s FOMC meeting. But one could also argue used car and truck prices have grown in a particular volatile way lately at annual rates between 20 percent and 44 percent in each of the past six months, skewing the core measure upward. There are always some components of the index that seem anomalous – on either side of the distribution. Discriminately cropping entire sectors from the CPI may not be the best method for teasing out true underlying price pressures.
Paul Krugman reports looking more and more to the Cleveland Fed “trimmed” inflation measures, which exclude outlying large price movements; the ultimate trim is the median, the rise in the price of the median category. Core CPI has been behaving erratically lately, making him doubt whether it’s still a good guide to underlying inflation (by which he mean the trend in prices that, unlike commodity prices, have a lot of inertia). Calculated Risks neatly puts the core CPI, and the two Cleveland Fed measures of inflation (median and trimmed mean) on the same graph. In a following post, Krugman notes that the Fed tends to focus on the core personal consumption expenditure deflator. There are some strange bobbles in this measure, suggesting that it’s not as good a measure of inertial inflation as advertised, but leaving that aside we see, once again, serious disinflation as a result of the recession.
The FT Money Supply blog notes that although the FOMC agreed that core measures of inflation were likely to remain subdued, there was no consensus about whether inflationary risks are weighted to the upside or downside. Energy prices had dropped back in recent weeks, but many participants saw upward pressures on commodity prices associated with expanding global economic activity as an inflation risk. However, some noted that the high degree of slack in resource utilization posed a downside risk to inflation. Survey measures of expected future inflation were fairly stable, but some market-based measures of inflation expectations and inflation risk suggested continuing concern among market participants about the risk of higher medium-term inflation, perhaps reflecting large fiscal deficits and the size of the Federal Reserve’s balance sheet.
Mark Thoma does not get why the consensus macro forecasts does not show much of a fall in inflation despite the high level of unemployment. Based on a recent economic letter from the San Francisco Fed, this is the explanation he has to offer to solve this puzzle. If there is a difference in the relationship between inflation and unemployment depending on the state of the economy, and if people form their expectations based upon data from normal times when the "loose empirical relationship" is operative, that could cause people to underestimate the change in inflation corresponding to changes in unemployment.
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