A Deeper Look at CPI or Why the Federal Reserve is Out-Of-Touch

From Bloomberg:

Prices paid by U.S. consumers rose more than forecast in September as food and energy costs climbed, while core measures showed inflation remains contained.

The 0.3 percent increase followed a 0.1 percent decline in August prompted by falling oil prices, the Labor Department said today in Washington. So-called core producer prices, which exclude fuel and food costs, rose 0.2 percent for a second month in line with forecasts.

With inflation under control, Federal Reserve policy makers have leeway to consider cutting their benchmark rate again later this month to keep the economy growing in the face of a deepening housing recession. Fed Chairman Ben S. Bernanke this week reiterated the central bank would ``act as needed'' to foster sustainable growth along with price stability.

``A slower economy and additional slack in the labor market should help keep inflation under control,'' Ethan Harris, chief economist at Lehman Brothers Holdings Inc. in New York, said before the report. ``Tame inflation and weaker growth imply additional rate cuts.''

Economists had forecast consumer prices would rise 0.2 percent after a 0.1 percent decline the prior month, according to the median of 82 projections in a Bloomberg News survey. Estimates of the increase ranged from no change to a 0.5 percent gain.

Let's ignore the headline number and look at the following two paragraphs from the BLS release:

Consumer prices increased at a seasonally adjusted annual rate (SAAR) of 1.0 percent in the third quarter of 2007, following increases in the first and second quarters at annual rates of 4.7 and 5.2 percent, respectively. This brings the year-to-date annual rate to 3.6 percent and compares with an increase of 2.5 percent for all of 2006. The index for energy, which advanced at annual rates of 22.9 and 32.9 percent in the first two quarters, declined at a 14.8 percent rate in the third quarter of 2007. Thus far this year, energy costs have risen at an 11.7 percent SAAR after increasing 2.9 percent in all of 2006. In the first nine months of 2007, petroleum-based energy costs (energy commodities) advanced at a 20.6 percent rate and charges for energy services (gas and electricity) increased at a 1.3 percent rate. The food index rose at a 5.7 percent SAAR in the first nine months of 2007 after advancing 2.1 percent in all of 2006. Grocery store food prices increased at a 6.7 percent annual rate in the first nine months of 2007, reflecting acceleration over the last year in each of the six major groups. These increases ranged from annual rates of 4.0 percent in the index for other food at home to 17.7 percent in the index for dairy products.

The CPI-U excluding food and energy advanced at a 2.5 percent SAAR in the third quarter, following increases at rates of 2.3 percent in each of the first two quarters of 2007. The advance at a 2.3 percent SAAR for the first nine months of 2007 compares with a 2.6 percent rise in all of 2006. The deceleration largely reflects a smaller increase in the index for shelter and a downturn in the index for apparel. Shelter costs, which rose 4.2 percent in all of 2006, have risen at a 3.2 percent annual rate in the first nine months of 2007. The index for apparel, which last year registered its first annual increase since 1997, has declined at an annual rate of 1.7 percent thus far in 2007. The annual rates for selected groups for the last seven and three-quarter years are shown below.

So -- why am I focusing on these two paragraphs rather than the headline number? I am personally having a really difficult time believing the "headline" inflation number largely because my personal experience just isn't jibing with an "inflation is benign" scenario. Here's why. I go shopping every 4-5 days. Over the last year or so I have seen chicken increase from about $4-$5 to $7-$8. Milk is now almost $4/gallon when it use to be $2.99/gallon. Simply put, the numbers just aren't adding up. While I don't know what is wrong exactly with the BLS' calculations and/or methodology, it simply isn't tracking what I am seeing at the retail level. Now I realize that the prices above are for food which isn't part of "core" inflation. This also illustrates how incredibly stupid the Fed's reliance on "core" inflation is. Core inflation is a great measure if you don't consume food or energy. For that small minority of the population that actually does consume food and energy, total inflation is a hell of a lot more relevant to daily life.

Let's look at three sentences from the first indented paragraph from the BLS report:

This brings the year-to-date annual rate [of total consumer prices] to 3.6 percent and compares with an increase of 2.5 percent for all of 2006.

Thus far this year, energy costs have risen at an 11.7 percent SAAR after increasing 2.9 percent in all of 2006.

Grocery store food prices increased at a 6.7 percent annual rate in the first nine months of 2007, reflecting acceleration over the last year in each of the six major groups.

These three sentences -- which are part of the BLS report -- are not reported in the financial press. And they sure should be because they show some serious price acceleration for goods we have to buy in modern society.