Inflation Measure Should Include Food and Energy Prices, Says Fed Official

In February 2000, the Federal Reserve discarded the US Consumer Price Index as its preferred measure of inflation and adopted the core Personal consumption expenditures price index (PCE) or core index.

In explaining the switch at the time, the Board stated: The chain-type price index for PCE draws extensively on data from the consumer price index but, while not entirely free of measurement problems, has several advantages relative to the CPI.

One irksome aspect of the core index is that it does not include products that can have temporary price shocks, in particular, energy, and food products. The idea is that it is therefore a better predictor of underlying long-term inflation

This annoys economists who argue that the core index is only relevant if you don’t eat and never leave your home. Now a senior Fed official has added his voice to the growing chorus of those who favor ditching the core index.

Federal Reserve Bank of St. Louis President James Bullard says the Fed should use a measure of headline inflation that includes food and energy prices. In doing this, they would move away from their emphasis on keeping “core” inflation in check.

Bullard said, “The logic of relative prices suggests that if households are forced to spend more on energy consumption, then they have to spend less on the consumption of all other goods, thereby putting downward pressure on all other prices [and all other expenditures] in the economy.”

He added, “Ignoring energy prices would then understate the true inflation rate, as one would be focusing only on the prices facing downward pressure because of changing relative prices.”

Bullard’s argument, more fully detailed here, is simply that the core index is inaccurate and unrealistic. The actions taken by the Fed to respond to inflation are therefore also inaccurate and can end up doing harm to the economy.

Politically, since the core inflation rate tends to track lower than the PCI, it has political connotations, especially for politicians who do not want to be seen as creating inflation.

In April, core inflation was pegged as 1.3% over the previous year. However, the CPI rose 3.2% in the same period. Which was the more realistic number for you in your daily life? Which measure should be used?

Tags: Consumer Price Index, core index, CPI, featured, Federal Reserve, interest rates, prices

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