The headlines are all about the "steepest decline in 15 years," as the all-items CPI fell by over 3% at an annual rate for the month, due mostly to declines in energy prices. But core indicators of inflation were far less tame, with the CPI excluding food and energy up 1.9% and the Median CPI of the Federal Reserve Bank of Cleveland registering a 3.6% increase. Over the past 12 months the all-items and ex. food and energy CPIs both rose 2.7% while the Median CPI was up 3.7%.

The Median CPI has now been rising at a rate in excess of 3% for over a year and above 3½% since October 2000. This is nearly one full percentage point above the increase in other measures of core inflation. The main reason for this is the continued divergence between goods and service price inflation, and especially outsized increase in housing costs (which account for one-half of services). Over the past twelve months, the price index for owner equivalent rent is up 3.9%. As is the case this month, with its 20.7% weight this component is often the median good.

Most forecasters continue to maintain that core inflation will fall to close to 2% by the end of this year. They may be right, but if they are, then housing market will have to collapse. Recent data surely suggest the opposite, leading me to conclude that we are in for continued inflation in the 3% range.

While I may be worried about inflation, it is not even my primary concern. Recent GDP revisions reporting lower corporate profits, business investment and productivity over the past few years than we had originally thought and very troubling. This suggests that both sustainable growth and the equilibrium real interest rate may be lower than we had hoped. Sustainable growth may not be much above 3% and the equilibrium real interest rate could be below that. All of this will be taken into account when the FOMC meets next Tuesday, as they try to figure out how low the federal funds rate should go. I figure they will ease by 25 basis points, setting the federal funds rate at 3½%, and then wait until at least November.

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