The war over inflation

MARK WILSON/Getty Images News Bear with me: The following is a bit arcane, but it may be hugely important to your bottom line. Critics of the U.S. Federal Reserve have been saying for months that the Fed unduly focuses on so-called “core inflation,” which excludes volatile food and energy prices and thus understates the “true” ...

598158_071114_bernanke_05.jpg
598158_071114_bernanke_05.jpg

MARK WILSON/Getty Images News

Bear with me: The following is a bit arcane, but it may be hugely important to your bottom line.

Critics of the U.S. Federal Reserve have been saying for months that the Fed unduly focuses on so-called "core inflation," which excludes volatile food and energy prices and thus understates the "true" amount of pain U.S. consumers are feeling at the cash register. As oil analyst Fadel Gheit explains in this week's Seven Questions:

MARK WILSON/Getty Images News

Bear with me: The following is a bit arcane, but it may be hugely important to your bottom line.

Critics of the U.S. Federal Reserve have been saying for months that the Fed unduly focuses on so-called “core inflation,” which excludes volatile food and energy prices and thus understates the “true” amount of pain U.S. consumers are feeling at the cash register. As oil analyst Fadel Gheit explains in this week’s Seven Questions:

By excluding food and energy [from core inflation figures], we are really misleading people. From the gas pump to the supermarket to the department store, everything that you bought a year ago would cost you more today. I’m not saying it’s only energy that is causing this, but energy is a major component of the cost increase because it impacts everything we do.

Some critics, such as market strategist Barry Ritholz, even say that alternative, non-core official measures such as the consumer price index (CPI) don’t adequately capture “the true price increases of the real world.” Yet the prevailing view among economists has been, as this 2006 paper (pdf) published by the Federal Reserve Bank of Philadelphia argues, that focusing on core inflation is the nonetheless the right way to go.

But that may be changing as oil prices remain high. Dallas Federal Reserve Bank President Richard Fisher, for one, is also unhappy about the Fed’s reliance on core inflation:

[I]n a speech prepared for delivery to an Australian economists group in Sydney … Fisher said he was uncomfortable about ignoring the trend in energy and food prices and noted that it was rare for core and food inflation to diverge for very long.

“A spread of the current magnitude between food price inflation and the core index occurred on several occasions between 1957 and 1980. But we have not seen it in a quarter century,” he said.

Fisher issued other complaints about the way the U.S. government measures inflation last year.

Well, now it appears that Fed Chairman Ben Bernanke has taken some of these concerns to heart. Bloomberg reports:

For the first time, the Fed will give forecasts for inflation both including and excluding food and energy costs, using the Commerce Department’s personal consumption expenditures price index. Fed officials say so-called “core” inflation is easier to predict given greater volatility of food and fuel prices and had shifted in 2004 to core forecasts only.

(As an aside, the Fed prefers the personal consumption expenditures index or PCE to the CPI because the former accounts for people changing their spending habits due to high prices.)

What real-world effect this shift will have remains to be seen, but it’s good to see the Fed isn’t ignoring this problem any longer.

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