The Inflation Update: September 2007
Stephen G. Cecchetti
15 November 2007

Waltham, Massachusetts

This month's consumer price report continues the string of good news that started last spring.  The BLS concluded that for the month of October the all-items CPI increased 3.6 percent at an annual rate, and is up 3.5 percent for the year.  But energy price rises account for one-third of this, so core measures were much more subdued. Excluding both food and energy, the traditional core CPI showed a very modest 1.9 percent (a.r.) increase for the month, which is below the 2.2 percent rise since October 2006.  My preferred core measures, computed by the Federal Reserve Bank of Cleveland, did show very slight bumps up, 3.2 percent (a.r.) for the median CPI and 3.4 percent (a.r.) for the 16 percent trimmed mean; but those are just one-month increases.  Over the past 6 months, virtually ever CPI-measure of inflation suggests a trend of 2.5 percent or less.

This morning's new data contain can be read in two ways.  The first is that there is little to worry about.  Even though the dollar exchange rate has fallen 10 percent (on a broad trade-weighted basis) over the last 12 months, and energy prices are up 14.5 percent since last October, overall inflation hasn't moved much.  In fact, core goods prices (commodities excluding food and energy commodities) continue to fall, albeit at a very modest -0.2 percent annual rate. And owner equivalent rent, the biggest element of core services, is up 2.7 percent (a.r.).  All of this suggests that the inflation trend is fairly stable.

The alternative reading is more alarming.  Looking at the detailed information in the table below, we see that roughly two-thirds of the CPI (as measured by the weight) increased by more than 2 percent last month, with 60 percent rising in excess of 2.5 percent.  Since I believe that the inflation objective should be 2 percent on the headline CPI averaged over 3 years, those numbers are too high.  We need to keep a careful eye on this over the next few months.

Let me move on to a few words about the Fed and monetary policy.  The big news this week is the announcement of the FOMC's new communication policy. The big change is that they will now issue forecasts four times a year, and those projections (their term) will be for the next 3 years.  The procedure for generating these projections still confuses me: 19 people submit forecast trajectories that are all based on potentially different paths for interest rates, oil prices, exchange rates, fiscal policy, equity prices, and the like; and then we are given order statistics quarter by quarter.  If I figure out how to interpret this, I will write something down and post it.  But for now I am perplexed.

While I may be confused about what the projections mean, I am not confused about the continued decision of policymakers to focus their attention on core inflation indices.  Here is a quote from a November 10 New York Times column written by Bob Herbert:

"In an interview after [Chairman Bernanke's appearance at a Congresional] hearing, [New York] Representative [Maurice] Hinchey discussed the disconnect between official government reports and the reality facing working families. He noted that the unemployment rate does not include workers who have become so discouraged that they’ve given up looking for a job.

And the most popular measure of inflation, the Consumer Price Index, does not include the cost of energy or food, “the two most significant aspects of the increased cost of living for the American people.

The elite honchos in Washington and their courtiers in the news media are all but completely out of touch with the daily struggle of working families.”

This is obviously wrong.  Those of us in this business know that the headline consumer price index includes food and energy, as does the headline PCE index.  But neither a member of Congress nor a New York Times columnist seem to understand this.  So, I applaud Chairman Bernanke for saying yesterday that  "Ultimately, households and businesses care about the overall, or "headline," rate of inflation; therefore, the FOMC should refer to an overall inflation rate when evaluating whether the Committee has met its mandated objectives over the long run."  And I hope that other Federal Reserve officials follow his lead.

  

Consumer Price Inflation, Various Measures
(Through October 2007, all data s.a. at an annual rate)

Previous

All Items CPI

CPI ex Food & Energy

Median CPI*

16 Percent Trimmed Mean*

1 Month

3.6 1.9 3.2 3.4

3 Months

1.7 2.1 2.8 2.6

6 Months

2.8 2.3 2.6 2.3

12 Months

3.5 2.2 2.8 2.5

12 Months ended October 2006

 1.3 2.7 3.0 2.7
                            *Revised versions of the median and trimmed mean that utilized regionally disaggregated owner equivalent rent.

 

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

 

Detail for Computation of the Revised Median CPI- October 2007

Component

1-month

annualized percent change

Relative importance (Normalized)

Cumulative relative importance

Lodging away from home      

-16.2

2.7

2.7

Car and truck rental       

-14.4

0.1

2.8

Women's and girls' apparel   

-4.2

1.5

4.3

Men's and boys' apparel      

-3.9

0.9

5.2

Motor vehicle fees          

-2.7

0.5

5.7

Motor vehicle insurance     

-2.6

2.2

7.9

New vehicles      

-2.5

4.8

12.7

Used cars and trucks       

-1.7

1.7

14.4

Tenants'  and household insurance    

-1.5

0.4

14.7

Household furnishings and operations  

-1.4

4.5

19.2

Communication       

-0.5

2.9

22.1

Owners' equivalent rent of primary residence, Midwest Urban Region

0.8

4.7

26.8

Nonalcoholic beverages and beverage materials

0.9

0.9

27.7

Processed fruits and vegetables    

1.4

0.3

28.0

Motor vehicle maintenance and repair 

1.5

1.1

29.1

Personal care services      

1.7

0.7

29.8

Owners' equivalent rent of primary residence, Northeast Urban Region

1.9

5.5

35.3

Water and sewer and trash collection services

2.0

0.9

36.2

Tobacco and smoking products          

2.1

0.7

36.9

Meats, poultry, fish, and eggs      

2.4

2.2

39.1

Miscellaneous personal services       

2.5

1.2

40.3

Food away from home         

2.7

6.0

46.3

Dairy and related products          

2.8

0.9

47.2

Owners' equivalent rent of primary residence, West Urban Region

3.2

6.2

53.4

Other food at home         

3.3

1.7

55.2

Owners' equivalent rent of primary residence, South Urban Region

3.6

7.2

62.4

Medical care commodities     

3.9

1.4

63.8

Recreation           

3.9

5.4

69.2

Alcoholic beverages         

4.2

1.1

70.3

Footwear            

4.5

0.7

71.0

Cereals and bakery products          

4.7

1.1

72.1

Rent of primary residence   

5.6

5.9

78.1

Personal care products      

5.8

0.7

78.8

Miscellaneous personal goods         

7.1

0.2

78.9

Motor vehicle parts and equipment    

7.4

0.4

79.3

Medical care services        

7.7

4.9

84.2

Education           

9.1

3.1

87.3

Fresh fruits and vegetables        

11.5

0.9

88.3

Jewelry and watches          

11.7

0.3

88.6

Leased cars and trucks

15.1

0.6

89.2

Public transportation        

15.9

1.1

90.2

Gas (piped) and electricity         

16.2

4.0

94.3

Motor fuel         

18.9

5.2

99.5

Infants' and toddlers' apparel        

22.6

0.2

99.6

Fuel oil and other fuels   

36.0

0.4

100.0