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The Inflation Update: April 2001 Stephen G. Cecchetti 16 May 2001 The FOMC has now cut the federal
funds rate by 250 basis points in a period of just 4½ months. The statements that have accompanied these actions clearly
suggest that the Committee members are much more worried about near-term
growth prospects than they are about inflation.
But while they have been cutting nominal money-market interest
rates, inflation has actually been creeping upward – a trend that is
reinforced by the numbers released this morning.
All in all, short-term real interest rates (adjusted for inflation)
have fallen by over 3-percentage point in just six months.
This morning the BLS reported that
the all items CPI rose by 3.5% (at an annual rate) in April. While CPI excluding food and energy have risen 2.6% (a.r.)
for the month, the Median CPI of the Federal Reserve Bank of Cleveland
increased 3.9% (a.r). Over
the past 12 months, the headline CPI is now up 3.3%, while the CPI
excluding food and energy has risen 2.6% and the Median CPI has increased
by 3.5%. As I have written before, when the two measure of core inflation
deviate, there is a tendency for the CPI excluding food and energy to
catch up with the Median CPI, not the other way around. To some analysts, a report in
which overall CPI inflation roughly two-tenths below the forecasts
suggests that inflation is not a threat. Various economists are quoted
using terms like “tame,” and the FOMC’s statement yesterday
described inflation as “contained.”
Is it? My conclusion is no. The detail in the report shows
that energy and tobacco prices rose, while apparel and computer prices
fell. But the movements in
prices of these commodities all tend to be very poor indicators of overall
inflation trends. Looking at the more stable components, I see that both
owner-equivalent rent (OER) and medical care are flashing warnings signs
that inflation is continuing to increase.
For the month of April, OER rose a whopping 4.8% (a.r.), and is up
4.4% (a.r.) for the last three months – a clear acceleration over the
3.2% increase for the 6 months ending in October 2000.
Medical care inflation is now running at 5%+, a full percentage
point higher than one year ago. The
picture is not a pretty one, as trend inflation could easily be headed
well above 3% in the near future. The behavior of the long-term
market interest rates since beginning of the year suggests that the
inflation risks of the current policy stance are well understood.
When the FOMC began this round of funds rate reductions on January
3, the 10-year Treasury bond rate was below 5%.
Today, the same 10-year rate is hovering around 5½%, and so the
yield curve has steepened by a full 3 percentage points, suggesting that
financial market participants are concerned about the inflationary
potential of these rate reductions as well.
We can still hold out some hope
that my dire predictions will not come to pass.
Consider the last time the Committee cut interest rates this
aggressively—the 1989 to 1992 episode.
Beginning with a funds rate of 9¾% in mid-1989, interest rates
were steadily cut to 3% over a period of just over 3 years.
For the first year of the cuts, inflation rose from 4% to about 5½%,
before falling below 3% by the time the easing was complete.
I guess it could happen again. But importantly the Median CPI (and
inflationary expectations) fell during this entire episode, suggesting
that this time around things could be very different. Consumer
Price Inflation, Various Measures (Through April 2001, all data at
an annual rate)
For previous
updates, as well as my occasional essays on current policy issues,
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