- The Washington Times - Saturday, June 3, 2006

Inflation stepped up in April. The Commerce Department’s Personal Consumption Expenditure (PCE) price index, released the last Friday in May, rose half a percent over March. The Labor Department’s Consumer Price Index (CPI) for all urban consumers rose even faster, 0.6 percent. These represent unsettling annual rates of 6 to 7 percent.

Year over year, the same two indexes were up 2.9 percent and 3.6 percent, respectively, in April. The Labor Department’s alternative chained CPI, a more realistic series that takes account of short-term spending shifts in response to changes in the relative prices of goods and services, rose 3.1 percent, more in line with PCE inflation (also based on a chained index) but by no means comforting. The main villain again was energy price rises.

Energy-related cost pressures show signs of creeping into core or underlying inflation. (Traditional measures of core inflation exclude the volatile energy and food categories from overall prices.) It is underlying inflation that the Federal Reserve attempts to control through monetary policy.

The PCE core price index for April was 2.1 percent higher than a year earlier, the largest year-over-year rise in 13 months and pushing above the Federal Reserve’s 2 percent comfort level. The year-over-year increase in the Labor Department’s chained CPI core index also bumped up to 2.1 percent in April, the biggest rise in 14 months.

Month-to-month changes painted a worse inflation picture. Between March and April, the PCE core index was up 3 percent at an annual rate, and the unchained core CPI was up 3.6 percent (chained CPI data are not available seasonally adjusted).

Fed-refined measures of core inflation were also disquieting. The Federal Reserve Bank of Dallas calculates and reports monthly a “trimmed-mean” inflation rate based on PCE price data. Whereas the Commerce Department simply excludes all energy and food components from overall prices in its core inflation measure, the Dallas Fed’s methodology is more sophisticated. Instead of making large category exclusions, the trimmed-mean measure tests the individual monthly PCE price components for volatility and only excludes the noisiest items while retaining relatively stable components regardless of category.

Since January, the Dallas Fed’s core inflation rate, year over year, has averaged about 0.3 percentage point above both the Commerce and the Labor chained core rates. In April, the Fed rate was up 2.4 percent over last year compared with 2.1 percent for the Commerce and Labor chained estimates. Looking at month-to-month changes, the Dallas core index so far this year has increased on average 3 percent annually, the same figure as for April.

Fed Chairman Ben S. Bernanke has been saying core inflation is contained. That assessment is beginning to sound strained, and apparently at least one Fed official doesn’t share the chairman’s confidence.

Talking to reporters on May 22 following a presentation, Dallas Federal Reserve Bank President Richard Fisher spoke of the current inflation picture and his bank’s trimmed-mean core inflation rate. “I personally believe it [the trimmed-mean rate] is a better measure. It is time-tested,” he was quoted as saying. A Reuters headline later that day read, “Fed’s Fisher says inflation running too high.” In Mr. Fisher’s own words on recent core inflation, “The trimmed-mean PCE … gives rise to some discomfort on my part.”

At the time Mr. Fisher spoke these words, the latest Dallas Fed core price estimate was for March, which was up 2.3 percent over the previous 12 months. Four days later, the April data were published and showed a slightly higher year-over-year increase, seeming not to provide any relief for Mr. Fisher’s discomfort.

The Federal Reserve Bank of Cleveland also regularly calculates and reports an improved monthly core consumer inflation measure. The Cleveland Fed’s measure is a weighted median of all the component prices in the CPI. As such, it achieves relative stability by eliminating distortions from extreme price changes with a minimum of information loss. Studies have found it better forecasts inflation than the cruder, traditional CPI core index.

Since the beginning of the year the Cleveland Fed’s year-over-year median core inflation rate has been running a half-point above the Labor Department’s featured core rate. For April, the Fed’s median inflation index was up 2.8 percent over the same month a year ago and up a sizable 3.3 percent annualized over March.

The two Fed-refined core inflation indexes, as well as the traditional core measures, are saying what the Fed chairman and most Fed officials have not yet said, at least publicly: Underlying inflation is getting out of bounds.

There could be reason for the quiescence. The Fed may not want to create inflationary expectations, which would only make fighting inflation that much harder. One might say the other edge of the Fed’s data-improvement blade is now cutting its creator.

Given the widespread nonreporting of the Fed’s disconcerting inflation numbers, perhaps Chairman Bernanke and his colleagues can for a time enjoy some market serenity. But actions speak loudest, and the observant will bet the Fed’s Open Market Committee raises the federal funds target interest rate another quarter-point at its next meeting in late June, despite an expected slowing in economic growth to the 3 percent range for the rest of the year.

Alfred Tella is former Georgetown University research professor of economics.

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