When I was an undergraduate, my Macroeconomics professor stressed the importance of the Federal Reserve’s role in keeping inflation under control. But I always thought that it was strange that they separated “core” inflation from inflation. As he explained it, the Fed only uses “core” inflation figures when they make policy decisions because it excludes food and energy prices – the prices that tend to inflate the most. Needless to say, my professor did not like it when I said that sounded ridiculous because food and energy is a big part of consumer spending. What genius decided to do that?
“Irrational Exuberance”
Since before the days of Alan Greenspan (the former Fed Chairman) the Fed has relied on the “core” inflation figures to determine it’s interest rate policy. The Fed chose to exclude food and energy prices in their inflation equation because they determined that including them would make the data volatile and render it an inaccurate predictor of future inflation. Since then economists have debated the decision, the importance of including food and energy prices despite the volatility, and how the decision to exclude it has altered views of inflation and monetary policy.
“Food for Thought”
Now, almost twenty years later and with a new Chairman on board, economists have taken another look at the “core” inflation figures. Loretta Mester, the director of research at the Philadelphia branch of the Federal Reserve gives us “food for thought” regarding “core” inflation figures. Interestingly enough, the “core” indicators seem to be a dud. Keep in mind: the Fed uses a complicated set of economic indicators (the vital signs of the economy) as part of their equation to determine where inflation is. Any one indicator does not determine their policy – but it can alter it slightly. So there is no need to panic (at least, not immediately).
Her research showed that using “core” inflation figures, such as the data that disregards food and energy prices, is potentially dangerous for the economy. She explains that the arguments used for “core” inflation figures by Greenspan are also wrong. In so many words, removing food and energy prices does not make the data any less volatile, nor is the “core” inflation figure a good predictor of future inflation.
So what seemed like common sense to me when I was in college, which was argued by my professor (a hardcore Greenspan enthusiast) to be otherwise, has turned out to have some truth. All prices are relevant. I pay for food and energy, in addition to other necessities. Every other American pays for food and energy too. We all see how inflation has taken off in recent years, and yet this has been a long relied on statistic to downplay rampant inflation fears. So how could these brilliant economists in the Federal Reserve and the U.S. Government seriously justify eliminating food and energy prices from the inflation figures? Do they not pay for groceries or gas? If they don’t, I want their job.
~K
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