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CPI versus Core Inflation

Friday, September 23, 2005 | 11:30 AM

in Economy | Fixed Income/Interest Rates

Cpi_vs_core_inflation This will be the last in our series on inflation for today (hopefully).

As we noted earlier, there is historical precedent for Central Bankers looking at CPI inflation with the inflation data backed out of it.

A picture is worth a 1000 words, and the chart nearby is no exception. It explains the risk to those who ignore energy prices or other price increases. Focusing on the core data (ex- inflation) ultimately will lead you to miss the primary move in price rises and broader inflation.

As the chart shows, in 2002, CPI bottomed at exactly 1%. It moved nearly continuously up for the next 12 months. During the entire time of this rise in inflation, the so-called core rate was actually declining. The core rate hit was still falling, and kissed 1% in mid-2003 -- some 18 months after the CPI did.

This shows you how while inflation was clearly on the upswing during that entire period, those people who focused on the core rate were recieving misleading signals about price pressures. Indeed, to them prices appeared to be going lower while they were actually going higher.

You couldn't ask for a more perfect example of Inflation ex-inflation.

It was only in 2004 that the core rate began to tick higher, moving to 2% and then above. By then, it was quite late. Over the same period, CPI rose to 3 plus %.

Here's the Ubiq-cerpt™ from Jesse's WSJ column:

"The Fed yesterday raised short-term rates a quarter point for the 11th time in a row, to 3.75%. Some economists had hoped and (incorrectly) predicted the Fed would pause to see how Katrina's effects played out. But when the Fed acted, it was clear that policy makers remain more concerned about inflation.

They still paid homage to its beloved "core" inflation measure, trilling that it has been "relatively low." The core measure excludes food and energy prices because they are prone to swings that are, typically, outsized and temporary. But the core is increasingly outmoded as energy prices have undergone a sustained and sharp rise. "I think the Fed has started to think of [energy prices] as more of a core development," says Lehman economist Ethan Harris.

It's about time. But the Fed isn't just combating inflation. Though it doesn't say so directly, it's also fighting the insatiable risk appetite that it spawned by the shock of easy money it used to get us out of the post-9/11 malaise."

Source:
Fed Faces a Post-Katrina Conundrum: Slowdown in Growth, Rise in Inflation
JESSE EISINGER, LONG & SHORT
September 21, 2005; Page C1
http://online.wsj.com/article/1,,SB112727002671347063,00.html