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The Inflation Update: May 2004 Waltham, Massachusetts Inflation is right on target, so long as the target is 2½%.
That what this morning’s BLS release suggests.
While the all-items CPI rose 8% (at an annual rate) for the month,
core measures were more subdued. The
CPI excluding food and energy increased 2½% (a.r.) and the Median CPI
computed by the Federal Reserve Bank of Cleveland rose 2.7% (a.r.).
While these readings are above the 12-month averages (1.8% for the
CPI excluding food and energy, and 2.5% for the Median CPI), they are
somewhat below the average inflation over the past three month.
Looking at the detail of the report, we see further
evidence that CPI inflation is stabilizing at a 2½% trend.
For the month of May, owner equivalent rent rose 2.7% (a.r.), the
same as its 6-month average. And
medical care cost inflation has moderated as well, rising at 3.6% (a.r.)
in May, well off the average 5.2% (a.r.) of the past 6 months. Then there is food away from home.
As I pointed out in the April 2004 edition of the Update, this component of CPI is another useful predictor of
long-term inflation trends. Last
month, the cost of eating out rose 3.3% (a.r.), close to the six month
average of 3.2% (a.r.) – again, things seem to be stabilizing. Core goods and core services give the same sense that
inflation has hit the new trend. Commodities,
excluding food and energy commodities, rose 0.9% (a.r.) for the month, and
are up 0.6% in the six months since November 2003.
Services, excluding energy services, are up 2.1% (a.r.) in May,
which is below the 3.2% (a.r.) average of the last 6 months. Where does this leave the FOMC going into their
end-of-June meeting? Assuming
that their objective is in fact 2½% inflation, they are now in dangerous
territory. The problem is that
interest rate changes take 18 to 24 months to have an impact on inflation.
The implication is that inflation will continue to rise for 2 years
after the target federal funds rate returns to its long-run equilibrium
level of 4 to 5%. Since the
current policy seems unlikely to return the funds rate to these levels
before late 2005, this means that inflation will continue to rise for the
next 3 years! The question
we should be asking is not will the target up 25 or 50 basis points at the
next meeting, but how high interest rates will have to go in 2006 in order
to bring inflation back below 3 percent. Consumer
Price Inflation, Various Measures
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