- The Washington Times - Wednesday, June 28, 2006

Two years ago this week, the Federal Reserve’s policy committee began raising its target interest rate, the federal-funds rate, which had been 1 percent for more than a year. At each of the last 16 policymaking meetings, the Fed has lifted its short-term target rate a quarter-percentage point. That pattern will likely continue today, bringing the fed-funds rate to 5.25 percent.

The Fed’s latest action in its tightening cycle probably will not be its last. Many analysts expect another increase at the Fed’s August meeting. The fed-funds rate may need to rise further, perhaps even exceeding 6 percent. That would depend on the future trends in overall consumer-price inflation and in the economy’s underlying inflationary pressures, which the Fed gauges by focusing on so-called core consumer price indexes, which exclude the volatile food and energy sectors.

Inflation data have been quite worrisome in recent months. In May, for the third month in a row, for example, the core CPI increased by 0.3 percent. That had not happened in more than a decade. “During the first five months of 2006,” the Bureau of Labor Statistics reported earlier this month, the overall CPI “rose at a 5.2 percent seasonally adjusted annual rate (SAAR),” which is significantly faster than the increase of 3.4 percent for all of 2005. “Excluding food and energy,” the core CPI “advanced at a 3.1 percent SAAR in the first five months, following a 2.2 percent rise for all of 2005,” the BLS added. Moreover, during the last three months these annualized inflation rates have accelerated. For the three-month period ending in May, the compound annual rate for the overall CPI reached 5.7 percent; for the core CPI, that compound annual rate hit 3.8 percent. But some analysts attempt to downplay these worrisome movements. First, they focus on the change in the core CPI over the last 12 months (2.4 percent) or on the 12-month change of 2.1 percent in a similar statistic, the so-called core personal consumption expenditures index (which is calculated by the Bureau of Economic Analysis and said to be the Fed’s favorite). Then they pretend that these “core” numbers represent the best measure of inflation. In fact, as noted above, the core price indexes gauge the economy’s underlying inflationary pressures and measure the extent to which potentially one-off jumps in energy and/or food prices are “passed through” into all other consumer goods and services, a development that central bankers fear could lead to a spiral effect.

Since consumers purchase gasoline and heat and cool their homes with natural gas, the price changes for these energy products must be included in any statistic that purports to measure consumer price inflation. In either case, the recent, rapid acceleration of the overall inflation rate and the economy’s underlying inflationary pressures should concern the Fed.


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