All meeting participants remained concerned about the outlook for inflation. Although readings on core inflation had improved modestly since the spring, nearly all participants viewed core inflation as uncomfortably high and stressed the importance of further moderation. Participants expected core inflation to edge lower over time, in part as the pass-through of higher prices for energy and other commodities ran its course and as the moderate growth in aggregate demand likely led to a modest easing of pressures on resources. Some participants also highlighted the impact that movements in the prices of individual components of the price index, such as owners' equivalent rent and medical costs, could have on near-term readings on core inflation. More generally, participants stressed there was considerable uncertainty as to the probable pace and extent of the moderation in core inflation and that the risks around this desired downward path remained to the upside. Moreover, participants expressed concern that a failure of inflation to moderate as expected could entail significant costs if an upward drift in inflation expectations ensued.
OK -- let's translate this eco-geek talk.
1.) Everybody -- each Fed Governor -- was concerned about the inflation outlook. That means everybody from the most dovish to the most hawkish governor.
2.) Nearly everybody -- which I translate as more than a simple majority and most likely at least a super-majority (2/3) -- don't like the current inflation level.
3.) Individual CPI components -- Owner's equivalent rent and medical costs -- are raising eyebrows.
4.) The Fed has used language to the effect of "inflation will moderate over time" for the last few meetings. The problem is, "when"? We know inflation is on everybody's mind and most governor's don't like the current level. Despite the recent downward movement in CPI, the governors are still concerned.
So -- what are the Fed governors looking for? Looking at the latest CPI report, we see a gradual decline in core CPI. For overall CPI, September and October we see declines of .5% and in November we see a 0% advance. The bottom line is the raw numbers don't look half bad.
However -- let's look at the Cleveland Fed's median CPI:
According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.2% (3.0% annualized rate) in November. The median CPI is a measure of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics’ (BLS) monthly CPI report.
Then there is the Dallas Fed's Trimmed Mean PCE:
The trimmed mean PCE inflation rate for November was an annualized 1.2 percent. According to the BEA, the overall PCE inflation rate for November was 0.1 percent, annualized, while the inflation rate for PCE excluding food and energy was 0.5 percent.
The 12-month rate of change was 2.4%. While the 12-month number has decreased for the last 3 months, it is still at an uncomfortable level for the Fed.
I am beginning to suspect these alternate inflation measures carry a bit more weight with the Fed than they are letting on.
5 comments:
The market sure turned skittish when this news came out. One moment it was up 0.8 percent, and the next I saw it dive in a straight line down 0.4 percent. The VIX shot up, indicating that this is a timely little reminder that volatility has not become obsolete despite the calm and tranquility of 2006.
Nothing can unsettle the soft-landing optimists quite as much as a hyper-sensitive Fed.
I suspect we will see yet another increase in CPI due to the health insurance rate increase and the rising energy costs. For instance, customers in my hometown of Baltimore
will be hit with not a rate increase, but a payback on a loan taken out by BGE. Despite the warm weather, this increase can make a difference for some. Gas prices--well, they're already on the rise. Healthcare? 6-11% increases have kicked in on Jan 1. Nice, eh?
The CPI commonly used for adjusting prices and benefits in the USA excludes food and energy from its basket of goods and services. The justification for this exclusion several decades ago was that it reduced the volatility of the index. That was perhaps reasonable when the excluded items were purely volatile, going down about as much as they went up, so that the long term effect on prices was zero, and the CPI was not biassed by the decision. However! In recent years we have seen not only volatility in energy prices, but also a major *trend* upward in the price of petroleum. The CPI therefore is now significantly misrepresenting economic reality. As the price of petroleum goes up, it becomes a larger component of the real consumer basket, so this misrepresentation has become more and more significant. If the price of petroleum continues to rise faster than other prices (as I expect), the error in the CPI will become an even more serious issue in the future.
I say that using an inflation index that is systematically biassed is bad public policy. The CPI is what everyone takes to be 'inflation', because it is written into contracts and determines COLAs, and so any systematic bias in the CPI produces a systematic bias, and in fact a misrepresentation, in practically all economic discussions and decisions in our country.
Bonddad, do you agree with the above statements?
If so, do you think that the new Congress should be encouraged to order that energy be restored to the CPI basket?
Two technical notes:
1) Apparently food prices are no longer as volatile as they once were, and so the argument for excluding them has been weakened.
2) In the context of the present thread of discussion, probably the Federal Reserve board members make decisions based not only on the CPI, but also on the broader indicies of inflation.
-DonInVA
Obligatory disclosure -- I am retired, and receiving Social Security benefits. The benefits are indexed to the CPI-U, so restoring energy to the CPI basket would be highly likely to directly benefit me.
Don --
I have had problems with CPI for about 1 year (at least) for several reasons.
1.) They use "owner's equivalent rent" instead of home prices. This understated the recent housing bubble. Considering housing comprises a large chunk of CPI (about 30% if memory serves) this is pretty bad.
2.) Health costs are underrepresented, especially over the last few years.
I hadn't thought about the energy issue, but your argument makes sense.
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