- The Washington Times - Thursday, March 23, 2006

When the Labor Department reported on March 16 that core consumer inflation, seasonally adjusted, rose in February by 0.1 percent, half as much as economists had expected, the media variously characterized the increase as tame, mild and well-behaved.

Yields on Treasury securities dropped, the stock market rose, and betting increased on Wall Street that the Federal Reserve would soon stop raising the Federal Funds rate. The news was welcome and widely reported.

Three hundred miles away, the Federal Reserve Bank of Cleveland reported the same day that core consumer inflation in February rose by 0.3 percent or a 31/2 percent annual rate, the largest monthly increase in four years. The Fed’s announcement was largely ignored by the media.

Which inflation report was right? Did core inflation slow or accelerate? The economic implications are not small. Some data are more equal than others.

The Labor Department’s measure of core inflation simply excludes food and energy prices from total consumer prices, a longstanding technique that removes the two most volatile categories to better capture the underlying trend in inflation.

However, it’s a rough measure that uses a meat-cleaver approach. It chops away all the components in the food and energy categories even though not all of them may be volatile or obscuring the trend rate of inflation. At the same time, it includes other price components that may be noisy and should be excluded from the total.

An alternative, more finely tuned, core price measure is regularly calculated and reported by the Cleveland Federal Reserve Bank. It’s a weighted median consumer price index that removes the noise in all price categories and retains the more stable midpoint of the distribution of monthly price changes. According to the Cleveland Fed, analysis shows that the median price index “provides [a] better measure of core inflation.”

The monthly percent change in the Cleveland Fed’s core inflation index has exceeded the Labor Department’s traditional measure in three of the last six months (in September, December and February) and was the same in the other three months. Last month the gap between the two measures widened. According to the Labor Department, the increase in its core rate was 0.2 in January and slowed to 0.1 percent in February, while the Fed’s estimate was also 0.2 in January but rose to 0.3 percent in February.

Year-over-year, the Labor Department’s core measure rose by 2.1 percent in both January and February, while the Fed measure rose by 21/2 percent in both months and increased the gap between the two series from the prior three months.

The message of worsening inflation is supported by another measure of core inflation calculated and reported monthly by the Federal Reserve Bank of Dallas. The Dallas Fed’s “trimmed-mean inflation rate” is based on personal consumption expenditure data from the Commerce Department, which also reports a basic core inflation rate that simply excludes food and energy from total prices.

In calculating the trimmed-mean core inflation rate, the Dallas Fed excludes volatile price components each month regardless of category. Fed researchers compared and tested their core inflation estimates against the Commerce Department’s traditional core rate and concluded the “resulting inflation measure has been shown to outperform the more conventional ‘excluding food and energy’ measure as a gauge of core inflation.”

The data for January (latest available) showed a one-month change in the trimmed-mean inflation rate of 3.1 percent annualized, up sharply from 1.6 percent in December and the highest in a year. By comparison, the Commerce core rate rose considerably less, by 1.9 percent annualized in January, up slightly from 1.7 percent in December.

On a year-over-year basis, trimmed-mean inflation also has been running higher than the traditional core measure. For the six months ending in January, the Fed rate averaged 2.2 percent above a year earlier compared to the Commerce Department’s 1.9 percent. With the traditional rate lower in January than in December and the Fed rate remaining unchanged, the gap between the two widened.

In sum, the preferred price measures show core inflation has recently taken a turn for the worse, contrary to news reports.

Economic behavior is influenced by what people are told. Ironically, the media, by focusing on the government’s lower numbers rather than on the Fed’s better measures of core inflation, may be doing Fed Chairman Ben Bernanke and his colleagues a favor. The news of low inflation helps keep the public’s inflation expectations contained, thereby making the Fed’s job that much easier.

The Fed developed its core price measures to get a better fix on underlying inflation. With its better data largely ignored by the media, the Fed for the moment seems to be getting the best of both worlds.

Alfred Tella is former Georgetown University research professor of economics.

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