The Inflation Update: October 2005
Stephen G. Cecchetti
16 November 2005

Waltham, Massachusetts

Well, things have calmed down slightly.  Oil prices are back to where they were in the summer, and the BLS reports that retail gasoline prices are down by 4.5% for the month (seasonally adjusted) -- that's an annual rate of 42%. Even so, the all-items CPI increased at a 2.4% annual rate (a.r.) for the month. While it is well below the 15.7% (a.r.) increase last month, it still suggests somewhat higher inflation than we have become accustomed to.  And at least one core measure confirms that inflation could be on the rise.  The traditional CPI excluding food and energy increased 3.0% (a.r.) in October, and is now up 2.1% for the past 12 months.  Meanwhile, the Median CPI computed by the Federal Reserve Bank of Cleveland rose a much more modest 1.9% and the 16% trimmed mean (added to the table below) increased 2.3% for the month.

While I continue to believe that the inflation trend is in the vicinity of 2.5%, the detail in this month's report suggests reasons for mild concern.  While core goods prices (commodities excluding food and energy commodities) were unchanged, core services prices (services excluding energy services) increased at a 4.0% annual rate.  This is well above the recent trend of between 2 and 2.5%.  Importantly, overall core service prices accelerated even though owner equivalent rent (OER), which accounts for one-half of core services, rose a very modest 1.6%.

In the past I have noted that volatile energy prices feed through to OER in a perverse way.  This month, the very dramatic 67% (a.r.) rise in "Fuels and Utilities" (likely caused by natural gas price increases) has depressed OER inflation. Here's what happens:  OER is based on a rental survey.  Renters pay fixed nominal rent that often includes utilities.  The BLS allocates this total rent paid between utilities and the part for the housing services.  When utilities prices rise, renters are presumed to pay less for housing services. Since October 2004, the energy portion of housing is up 18.4% while OER is up 2.3%.  As a result, the total cost of housing in the CPI (which account for more than 40% of the index) is up 3.9%.  The point of all this is that when the price of energy used in housing stabilizes, or even begins to fall, OER is likely to rise again.

Two additional aspects in this morning's report deserve modest attention.  First, "Food Away from Home" increased 3.8% (a.r.) for the month, and is now rising at a trend near 3.5%. And second, medical care prices seem to be on the way up again too.  Regardless of whether you look at medical care services, medical care goods, or their combined total, the October increase is about 6.5% (a.r).  This is well above their 3 to 4% trend.  While a relatively small 6.1% expenditure share in the CPI, medical care is twice as important in the Personal Consumption Expenditure Price Index the Fed seems to prefer.

Speaking of the Fed, Ben Bernanke now has taken center stage. If everything goes as planned, on February 1, 2006 he becomes 14th Chairman of the Board of Governors of the Federal Reserve System.  And, he will take the helm of American monetary policy.  There may be no one in the world more qualified for the job and I applaud the President's choice!

It is natural that some uncertainty surrounds turnover in such an important position.  In this case, the press and financial markets have focused on several questions: What will Ben do?  Will he be tough just to establish his anti-inflation credentials?  Will he push his FOMC colleagues to publicly announce a long-term inflation objective?  Will he comment on fiscal policy and the deficit?  Let me give my answers.

First, I feel very strongly that Mr. Bernanke will do what he thinks is the right thing.  He inherits a credible, low inflation policy that has been run by a committee.  Virtually nothing has changed, with the exception of the Chairman. So, I see no reason to think that policy will become overly tight just to build credibility.  

As for a change in what the Fed says and when they say it, here I believe we will see some changes—but not immediately. It is important to keep in mind that US monetary policy has become increasingly transparent during the Greenspan years and Ben was part of that process.  As it currently stands, the FOMC announces its policy action after every meeting and includes a brief statement of explanation.  Then, three weeks later we get detailed minutes.  And throughout the course of the year, Governors and Reserve Bank Presidents publicly comment on the state of the economy and the appropriate policy.  Ben will simply continue along this road.  My best guess is that he will be able to get agreement on a long-term inflation objective and publish it.  In addition, he may move to publish some form of inflation and growth forecasts.  My hope is that the FOMC will also provide quarterly reports, doubling their biannual frequency of the Monetary Policy Report to Congress (that is no longer legally required).

Finally, there is the issue of the Chairman of the Federal Reserve Board commenting on other economic policy matters.  In thinking about this issue, it is important to keep in mind that regardless of how any central bank governor might phrase it, a person in such a position cannot speak publicly in a personal capacity. They speak for their institutions, always.  This goes for Ben Bernanke, too. While he will have an obligation to speak about monetary and financial policy, on matters of tax and expenditure policy, the new Chairman Bernanke should restrict their comments to issues that directly influence their ability to do their job.  When politicians’ actions threaten the ability of monetary policymakers to deliver price stability, then central bankers have an obligation to speak. 

Consumer Price Inflation, Various Measures
(Through October 2005, all data s.a. at an annual rate)

For previous updates, as well as my occasional essays on current policy issues,
Please visit my home page:
www.brandeis.edu/~cecchett

 (Note:  If you have trouble viewing the tables, you may prefer looking at them in html at
 people.brandeis.edu/~cecchett/pdf/inf11_05.htm)