Thursday, June 7, 2007

Inflation and the Fed

In this morning's commentary on The Big Picture, Barry Ritholtz writes:

Of course, many pundits, traders and investors -- and a goodly part of the Federal Reserve -- have convinced themselves that there really wasn't any inflation, ...

I agree with Barry regarding the many pundits, traders, and investors that have convinced themselves that there really wasn't a reason to worry about inflation (just look at the stock market action of the past few months), but I disagree that many Federal Reserve policy-makers are not concerned about inflation.

I know I've said it before on Barry's blog, but I'll say it again here: I worked at a Federal Reserve District Bank in 2004-05 as an economic research analyst - assisting the economists with their research.

There was much discussion regarding the measurement error of core CPI beginning in early 2005. That's about the time the Cleveland Fed came out with their median CPI measure, and the Dallas Fed - whose head of research is mentioned in Barry's post - created their trimmed mean PCE measure. Furthermore, the FOMC minutes have stated for some time that the main concern of the Fed is that inflation will fail to moderate as expected (i.e. inflation - by whatever measure they're now using - is above their comfort zone).

I'm not aware of the evidence Barry has seen that suggests that a good part of the Federal Reserve have convinced themselves that there is no inflation. One could argue that - given inflation data - the Fed should raise rates, but this is what is discussed/argued in FOMC meetings.

Here's an interesting excerpt from the Reuters article referenced in Barry's post:
On the other hand, Rosenblum said that because the Fed relies on a number of different measures of price pressure, there was not much risk the flaws in core inflation would translate into a policy mistake.

"The fact that core is misbehaving now because food and energy are moving in one direction instead of up and down is not all that troublesome to me because we have the good sense to look at the wide range of indicators out there," he said.


barry said...

The reference is to the focus on the core rate in the face of 5 years of rising food & energy prices...

Josh Ulrich said...

I understand, but my critique still holds. The "core" inflation measures on both the District Fed pages I referenced show inflation rates designed to remove volatility, not necessarily food and energy.

Visit the pages and you'll see that the year-over-year percentage changes of median CPI, 16% trimmed mean CPI, and trimmed mean PCE have all been higher than their respective headline rates for the past 6 months. That hardly suggests an understatement of inflation.

barry said...

That's a choice they have to make.

The Fed can choose to exclude volatility (unlike most ocentral bankers) -- but then they can deal with the fallout from a loss of confidence.

Consumers know prices, and they know that over the poast few years, prices have either gone up, or gone up faster.

If a loss of credibility is not important to the Fed, than they should maintain their focus on the core rate.

But they cant have it both ways . . .

Josh Ulrich said...

It's not assured that there will be a loss of confidence/credibility if the Fed excludes volatility (even if most inflation-targeting central banks do not). Volatility can go both ways. The charts in Is Inflation Moderating? show that headline inflation has moderated faster than core inflation over the past year. Certainly that volatility should be excluded from monetary policy decisions...

Of course prices have either gone up, or gone up faster. There hasn't been a year-over-year decrease in the CPI-U price level for nearly 50 years.

Thanks for the comments!