Core Inflation Conundrum

The Washington Times (Washington, DC), January 28, 2007 | Go to article overview
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Core Inflation Conundrum


On Jan. 18, the Bureau of Labor Statistics (BLS) released its report on the consumer price index (CPI) for December with apparently heartening news about inflation.

After accelerating during the first three quarters of 2006, core inflation (measured by the CPI excluding energy and food prices, which tend to be volatile and obscure the underlying trend in overall prices) slowed in the final three months of the year.

This improvement was presumably due to Federal Reserve policy. The good news about inflation was widely reported in the media. Still, members of the Fed's policymaking Federal Open Market Committee (FOMC) continue to say the main inflation risk is to the upside.

Though Fed officials favor the tamer (and less timely) inflation numbers from the national economic accounts as reported by the Commerce Department, they also closely watch the BLS consumer price data. The Federal Reserve system also produces its own measures of core inflation, notably a median CPI calculated each month by the Federal Reserve Bank of Cleveland that has been telling a different story than the BLS core index.

The traditional measure of core CPI inflation, which the BLS reports, excludes all energy and food prices from the overall index. It's a crude technique that throws out some nonvolatile items within the energy and food categories that can carry a valid signal of underlying inflation. It also retains other items that may be "noisy" and obscure the underlying trend. The Cleveland Fed's median CPI gets around these problems by taking another approach. It derives a weighted median index that excludes much of the noise in the BLS micro data and zeroes in on the more stable midpoint of the distribution of monthly price changes.

The Cleveland Fed's median CPI is based on the work of Michael Bryan, a vice president and economist at the Cleveland bank, and Stephen Cecchetti, an economics professor at Brandeis University. A thorough evaluation of the median CPI and its performance was made by the Cleveland Fed before it decided to adopt the measure and calculate and report it monthly on its Web site. To illustrate the bank's confidence in the data, the heading on one of its permanent Web pages reads: "Median CPI provides better measure of core inflation." Analysis showed the weighted median CPI was more closely correlated with past money growth than competing core inflation measures and yielded improved inflation forecasts.

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Core Inflation Conundrum


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