CPI versus Core Inflation

Cpi_vs_core_inflationThis will be the last in our series on inflation for today (hopefully).

As we noted earlier, there is historical precedent for Central Bankers looking at CPI inflation with the inflation data backed out of it. 

A picture is worth a 1000 words, and the chart nearby is no exception. It explains the risk to those who ignore energy prices or other price increases. Focusing on the core data (ex- inflation) ultimately will lead you to miss the primary move in price rises and broader inflation.

As the chart shows, in 2002, CPI bottomed at exactly 1%. It moved nearly continuously up for the next 12 months. During the entire time of this rise in inflation, the so-called core rate was actually declining. The core rate hit was still falling, and kissed 1% in mid-2003 — some 18 months after the CPI did.

This shows you how while inflation was clearly on the upswing during that entire period, those people who focused on the core rate were recieving misleading signals about price pressures. Indeed, to them prices appeared to be going lower while they were actually going higher.

You couldn’t ask for a more perfect example of Inflation ex-inflation.

It was only in 2004 that the core rate began to tick higher, moving to 2% and then above. By then, it was quite late. Over the same period, CPI rose to 3 plus %.

Here’s the Ubiq-cerptâ„¢ from Jesse’s WSJ column:

"The Fed yesterday raised short-term rates a quarter point for the 11th time in a row, to 3.75%. Some economists had hoped and (incorrectly) predicted the Fed would pause to see how Katrina’s effects played out. But when the Fed acted, it was clear that policy makers remain more concerned about inflation.

They still paid homage to its beloved "core" inflation measure, trilling that it has been "relatively low." The core measure excludes food and energy prices because they are prone to swings that are, typically, outsized and temporary. But the core is increasingly outmoded as energy prices have undergone a sustained and sharp rise. "I think the Fed has started to think of [energy prices] as more of a core development," says Lehman economist Ethan Harris.

It’s about time. But the Fed isn’t just combating inflation. Though it doesn’t say so directly, it’s also fighting the insatiable risk appetite that it spawned by the shock of easy money it used to get us out of the post-9/11 malaise."


Fed Faces a Post-Katrina Conundrum: Slowdown in Growth, Rise in Inflation
September 21, 2005; Page C1

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What's been said:

Discussions found on the web:
  1. nate commented on Sep 23

    How do increases in education costs (tuition, fees books) and increases in health care (nursing home cost per day) figure into inflation stats?

  2. Lord commented on Sep 23

    With energy prices rising so fast, is the only way for the Fed to contain inflation a recession? It is beginning to look that way. They will need to lower core inflation to 1% or less to keep the CPI in bounds. This may make an attractive target for them.

  3. Ralph commented on Sep 24

    Interesting. Shows we need some flexibility in thinking about this important macro-economic variable.

  4. Morris Rosenthal commented on Apr 11

    The CPI doesn’t measure inflation at all. It measures the cost of living, which is primarily about out-of-pocket expenses. This is what allows housing prices, education costs and health care inflation to be hidden over time. The first to are paid for on installments, so the interest rate and the terms control the “cost” and health care isn’t an out-of-pocket expense for most Americans!

    How the CPI Hides Inflation


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