Philly Fed: Don't Rely On Core Inflation

Thursday, May 22, 2008 | 10:30 AM

"We find that food and energy prices are not the most volatile components of inflation and that depending on which inflation measure is used, core inflation is not necessarily the best predictor of total inflation..."  (emphasis added)

-Core Measures of Inflation as Predictors of Total Inflation


You may have overlooked a recent research piece out of the Federal Reserve Bank of Philadelphia and the Wharton School at University of Pennsylvania. Don't.

The research team essentially found that Core Inflation is an erroneous way to measure ongoing price increases. Both of the main rationales offered for policymakers€™ for their focus on core measures of inflation do not survive close scrutiny, argues a group of researchers.

Their main findings were that:

-Other components of Inflation are more Volatile than Food & Energy;
-Core Inflation is less Valuable as Inflation Forecastor;
-Combining CPI and PCE inflation measures can lead to more accurate forecasts

Its worth noting that the shift in focus from total inflation to core inflation was a Greenspan era "innovation."

A quick excerpt:

"We find that core inflation, which omits food and energy prices, is less volatile than total inflation, but the reduced volatility comes from omitting the energy components. Several components of the CPI exhibit higher volatility than food prices. And an index that omits food and energy prices demonstrates slightly more volatility than a measure that omits only the energy components and retains the food components...

Perhaps most important, we find that including PCE inflation when forecasting CPI inflation and including CPI inflation when forecasting PCE inflation significantly improves the accuracy of the forecasting model for horizons up to one year. This suggests that each measure of inflation provides independent information that can be exploited to yield statistically significantly more accurate forecasts."

Now you have some reading for the holiday weekend . . .


Core Measures of Inflation as Predictors of Total Inflation
     Theodore M. Crone, Swarthmore College
     N. Neil K. Khettry, Murray, Devine & Company
     Loretta J. Mester, Federal Reserve Bank of Philadelphia and the Wharton School, University of Pennsylvania
     Jason A. Novak, Federal Reserve Bank of Philadelphia
Federal Reserve Bank of Philadelphia, May 2008

Download wp08-9.pdf

Thursday, May 22, 2008 | 10:30 AM | Permalink | Comments (17) | TrackBack (1) add to | digg digg this! | technorati add to technorati | email email this post



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» Death By Debt from Investment Advice, Personal and Individual Insurance, Investment
I decided to republish this information in light of the current economic crisis this country is facing now. This article first appeared on an older version of my website in January of 2007. Here we are a little more than a year later, and a little wors... [Read More]

Tracked on May 22, 2008 7:55:49 PM


In his June 2008 Investment Outlook, Bill Gross presents a chart showing that headline and core inflation have diverged for nearly 3-1/2 years now. And he's not confident that they will EVER converge again -- as they should, if core inflation is merely a less-volatile version of overall inflation.

Mathematically, there are several ways of suppressing volatility without excluding critical inputs such as energy prices. The Cleveland Fed publishes a median CPI. In its own Beige Book forecasts yesterday, the Fed employed trimmed means (excluding the three highest and three lowest of 17 forecasts).

Given these superior techniques, one has to question the stated agenda of reducing spurious volatility. Frankly, it's a lie. The agenda is to suppress the inflation rate, on an ongoing basis. Bill Gross says they've suppressed it by over a percentage point. I concur.

As the demise of the former Soviet Union showed, ultimately those chickens come home to roost. The estimated GDP of the Soviet Union ended up being slashed nearly in half, after the true state of its "value subtraction" economy became apparent in the early 1990s.

The United States is not that far along, although it accumulated a great deal of malinvestment during the Greenspan Bubble era, and not only in real estate. However, the federal statistics mill is one of the value subtraction sectors of the U.S. economy, along with Congress and the overblown financial sector. The longer the sham continues, the larger the step-function drop later. Lies, lies; tell me sweet, sweet lies!

Posted by: Jim Haygood | May 22, 2008 10:58:27 AM

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