If you were in Baltimore, Md., or Sydney Australia last week and followed the news about U.S. consumer inflation, you read that in March “core prices rose at the fastest rate in 12 years.”
If you were almost anywhere else, you read, as the Associated Press reported, that March showed “the biggest gain in core inflation in a year.” Big difference. Which story was right?
Both were right about the data they reported since there were two core inflation estimates released on the morning of April 19, one by the U.S. Bureau of Labor Statistics (BLS) and the other by the Federal Reserve Bank of Cleveland. But, as often happens in the topsy-turvy world of statistics, the second-best inflation number was given the widest publicity while the preferred estimate was mostly ignored.
It wouldn’t have greatly mattered if the two estimates told the same story. But they didn’t.
Core price indexes attempt to measure the underlying rate of inflation by eliminating the influence of volatile components. The resulting estimates of trend inflation powerfully influence markets and price expectations and, not least, the Federal Reserve’s interest rate decisions.
The BLS measure of core consumer price inflation simply excludes all food and energy components from the total index. In general, these components tend to be volatile from month to month, and their exclusion is the traditional, albeit outdated, method of computing core inflation.
By comparison, the Cleveland Fed’s core consumer price index is a weighted median of all the items in the consumer price index (the median is the point where half the price changes in the index are larger and half are smaller). It has the virtue of not excluding any price components in the overall index, yet greatly reduces the influence of extreme price changes. Creators of the median index found it better forecasts inflation than the traditional BLS core price index.
In March the BLS core price measure, seasonally adjusted, rose at a discomforting 4.2 percent annualized rate, the biggest monthly gain in a year. By comparison, the rise in the Cleveland Fed’s core index, accelerating for the third month in a row, reached an alarming 5 percent annualized rate in March, the biggest month-to-month increase since February 1994.
Compared to the same month a year earlier, the BLS core measure held steady in March at its February rate of 2.1 percent. The BLS also reported “chained” core prices in March rose 2 percent over the year, an alternative estimate that takes into account shifts in consumer purchases in response to change in the relative prices of goods and services. By comparison, the year-over-year increase in the Cleveland Fed’s median price index rose from 2.5 percent in February to 2.7 percent in March.
It looks as though higher energy costs have begun to spill over into general inflation. Energy-using industries that have been absorbing higher costs by drawing down profits may be starting to pass them on to their customers. With the price of oil at record levels of more than $70 a barrel, and considering the Fed’s price numbers, the inflation outlook has become, to put it mildly, worrisome.
The 2 percent upper limit of the Federal Reserve’s so-called inflation comfort zone has been breached. The gradual worsening of the Cleveland Fed’s core inflation measure in recent months suggests that the 5 percent annualized inflation rate recorded for March may not be a monthly aberration. Markets haven’t as yet fully absorbed this information, which has been largely ignored in the media. But the Fed does not suffer from recognition lag and has stated that its interest rate decisions will be heavily dependent on emerging economic data.
Financial markets are betting the Fed will continue to raise the federal funds interest rate only once or twice more, to 5 or 5 1/4 percent. But the Fed’s relatively optimistic outlook for the economy this year and its own elevated core price data suggest a federal funds ceiling of 5 1/2 to 6 percent may be more realistic.
Alfred Tella is former Georgetown University research professor of economics.