The Inflation Update

The first of these monthly inflation updates appeared in 15 December 1999, three months after I returned to academia from my two-year-long field trip to the Federal Reserve Bank of New York. This is the 97^th update, and it is the last. On Monday morning (10 March) I was appointed Economic Advisor and Head of the Monetary and Economic Department at the Bank for International Settlements in Basel, Switzerland. When I start on 1 July, I will be precluded from commenting on any individual country's monetary policy. Given my innate tendency to say whatever comes to my mind, I figure I had better start practicing being more restrained.

That said, let's have a look at today's inflation data. This morning, the BLS reported that the all-items Consumer Price Index (CPI) rose at a very modest 0.3 percent annual rate (a.r.) in February. Core measures were equally subdued, with the traditional CPI excluding food and energy up 0.5 percent (a.r) and the Median CPI computed by the Federal Reserve Bank of Cleveland rising 1.4 percent (a.r.). This one month's lull masks a general trend of substantially higher inflation. Looking over the past 12 months, we see headline CPI was up 4.0 percent, traditional core registered a 2.3 percent increase, and the Median CPI showed a rise of 3.0 percent.

My reading of the detail this month suggests that the dip in inflation is likely to be temporary. To see why, have a look information on core goods prices (commodities excluding food and energy). This portion of the CPI (the weight is a bit over 20 percent) fell nearly one full percentage point (a.r.) in February. Given that we import a good fraction of the goods we consume, and that the exchange value of the dollar has fallen precipitously over the past year, it is natural to wonder where this moderation is coming from. To get a hint, we can look at a few things. First, the six-month change in core goods prices is +0.5 percent (a.r.). Core goods prices are rising. And second, the decline is entirely a consequence of seasonal adjustment. The not-seasonally-adjusted core goods price series rose at a 4.2 percent annual rate for the month. Yes, that's right, seasonal adjustment turned a 4+ percent increase into a nearly 1 percent decline. I'm not usually one to worry about stuff like this. I simply accept the seasons adjustments as they come. But some years ago I learned that the simple mechanical algorithms used to adjust the data work poorly during business cycle turning points. So, in this case I'm very very suspicious.

The one bright spot in the report is owner equivalent rent (OER). The problems in the residential housing sector are clearly hitting rents. That may be bad for homeowners and landlords, but it is good for inflation. OER rose a modest 1.8 percent (a.r.) for the month, and is up only 2.6 percent over the last 12 months. This contributes to the fact that core service prices (services excluding energy services) have risen only 3.2 percent since February of 2007, and are showing very little sign of acceleration. Even so, this month's data does little to change my view that the trend in consumer price inflation is running in excess of 2.5 percent.

Turning to monetary policy, I have several comments. First, in addition to the swift cuts in the target federal funds rate, the Fed continues to be innovative in looking for ways to address the stress in the financial system. They have now committed nearly half of their $900 billion balance sheet to extraordinary actions. There is the Term Auction Facility (TAF) that provides loans to commercial banks ($100 billion). Next there is the policy of extending the term of repurchase agreements in daily temporary operations to 28 days ($100 billion). Then there is the Term Securities Lending Facility ($200 billion), and finally there are the swap agreements to supply dollars to foreign central banks ($36 billion). All of these policy innovations change the composition of the Fed's balance sheet without changing its size. The purpose of each one is to address specific credit spreads that have widened beyond what policymakers feel is justified by economic fundamentals. The TAF and the swaps are aimed at the term interbank lending market, while the securities lending program is directed at mortgage-backed securities.

Will all of this work? I hope it does, but I am skeptical. Financial institutions have stopped lending, and for the economy to getting moving they have to start again. But bank and nonbank suppliers of credit are all working to contract their balance sheets, not expand them. The reason is that there is a shortage of capital in these institutions. Every morning brings news of some institution needing capital -- this morning it happen to be National City Bank in Cleveland. In the end, recapitalizations require public funds. That means its the job of the Treasury, not the Federal Reserve.

Let me close with a short note to say that I have enjoyed writing these updates for the past 8 years. It has been both challenging and rewarding. And I appreciate the positive feedback I have gotten from many of you. Just prior to my move, I will send one final message with my new contact information.

Consumer Price Inflation, Various Measures
(Through February 2008, 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

Detail for Computation of the Revised Median CPI - January 2008
Component	1-month annualized percent change	Relative importance (Normalized)	Cumulative relative importance
Fresh fruits and vegetables	-22.7	0.9	0.9
Women's and girls' apparel	-22.0	1.6	2.5
Motor fuel	-21.2	5.7	8.2
Fuel oil and other fuels	-13.8	0.4	8.6
Lodging away from home	-13.4	2.6	11.1
Infants' and toddlers' apparel	-4.3	0.2	11.3
Personal care products	-3.9	0.6	12.0
New vehicles	-3.5	4.6	16.5
Leased cars and trucks	-1.7	0.6	17.2
Public transportation	-1.7	1.1	18.3
Nonalcoholic beverages and beverage materials	-1.5	0.9	19.2
Meats, poultry, fish, and eggs	-1.5	1.8	21.0
Communication	-0.1	3.1	24.1
Owners' equivalent rent of primary residence, Northeast Urban Region	0.1	5.2	29.3
Household furnishings and operations	0.2	4.7	34.0
Used cars and trucks	0.4	1.8	35.7
Footwear	0.6	0.7	36.4
Motor vehicle insurance	0.8	2.0	38.4
Owners' equivalent rent of primary residence, Midwest Urban Region	0.8	4.5	42.9
Medical care services	1.0	4.6	47.5
Motor vehicle fees	1.2	0.5	48.0
Recreation	1.4	5.6	53.6
Medical care commodities	1.6	1.6	55.2
Tenants' and household insurance	1.9	0.3	55.6
Rent of primary residence	2.3	5.8	61.3
Owners' equivalent rent of primary residence, West Urban Region	2.9	6.7	68.0
Owners' equivalent rent of primary residence, South Urban Region	3.1	7.5	75.6
Education	3.5	3.0	78.5
Motor vehicle maintenance and repair	3.7	1.1	79.6
Water and sewer and trash collection services	4.2	0.9	80.6
Food away from home	4.7	6.2	86.7
Personal care services	5.1	0.6	87.4
Alcoholic beverages	5.2	1.1	88.4
Miscellaneous personal services	5.2	1.0	89.5
Tobacco and smoking products	5.5	0.7	90.2
Motor vehicle parts and equipment	9.5	0.4	90.6
Dairy and related products	10.0	0.9	91.5
Miscellaneous personal goods	11.8	0.2	91.7
Other food at home	12.8	1.9	93.5
Men's and boys' apparel	14.4	0.9	94.5
Gas (piped) and electricity	22.6	3.8	98.3
Processed fruits and vegetables	22.9	0.3	98.6
Cereals and bakery products	23.8	1.0	99.6
Car and truck rental	35.4	0.1	99.7
Jewelry and watches	41.0	0.3	100.0

Previous	All Items CPI	CPI ex Food & Energy	Median CPI^*	16 Percent Trimmed Mean^*
1 Month	0.3	0.5	1.4	1.0
3 Months	3.1	2.3	3.0	2.7
6 Months	4.7	2.5	3.2	3.0
12 Months	4.1	2.3	3.0	2.8
12 Months ended February 2007	2.4	2.7	3.3	2.8
*Revised versions of the median and trimmed mean that utilize regionally disaggregated owner equivalent rent.

Detail for Computation of the Revised Median CPI - January 2008