- The Washington Times - Wednesday, September 13, 2006

The Commerce Department Aug. 31 reported the personal consumption expenditure core price index rose in July by only 0.1 percent, following a 0.2 percent rise in June. (The Commerce core price measure excludes the sometimes volatile energy and food components from the overall index.) The July increase was the smallest this year, and half what economists expected.

Expressed at an annual rate (and counting more decimals in the monthly change), the June-to-July increase in core prices was 1.7 percent, a full percentage point less than the average increase for the three previous months. By that measure July inflation was tame indeed.

But the picture was not so rosy year over year. Core prices were up 2.4 percent over July 2005, the highest rate in nearly four years and well above the Federal Reserve’s 1 to 2 percent comfort zone.

The emphasis in the media, not surprisingly, was on the small month-to-month rise. Typical conclusions were: “This tame core inflation reading reinforced the view that the Federal Reserve would not raise interest rates for the foreseeable future” (Reuters) and “the report should cement expectations that the Fed will hold rates steady again at the Sept. 20 meeting” (Market Watch).

Seemingly in another world, the Federal Reserve Bank of Dallas reported Aug. 31 that its “trimmed mean” measure of core consumer prices rose from June to July by 3.1 percent at an annual rate — more than a point above the Fed’s comfort ceiling. Year over year, the Dallas Fed’s core inflation rate was 2.7 percent, 0.3 point more than the Commerce Department’s core rate. The Dallas Fed also reported a six-month core inflation rate that registered 3 percent annualized, compared with the Commerce Department rate of 21/2 percent. The gap between rates has sharply widened between April and July, from 0.2 to 1.4.

Here we have two quite different pictures of core or underlying inflation. Which are we to believe? Or to give greater weight? More important, which rate does the Fed believe and what are the implications for monetary policy?

The Dallas Fed’s core inflation rate uses the same data inputs as the Commerce Department, but the Fed goes further in analyzing the data and maximizing information. While Commerce simply excludes the two broad categories of energy and food, the Fed looks at all detailed items, including those in the energy and food groups, and trims away the most volatile or “noisiest” prices each month regardless of category. The Fed has objectively analyzed both core series and concluded its trimmed mean rate is the more accurate measure of underlying inflation. Other economists agree.

The president of the Dallas Fed, Richard W. Fisher, supports the trimmed mean rate as a preferred measure of core inflation. In a talk on Aug. 30 to the North Dallas Chamber of Commerce, he rightly said “ex food and energy measures are but one form of the core rate, and — according to research at the Dallas Fed, the Cleveland Fed and elsewhere — not even necessarily the best.”

Federal Reserve Chairman Ben S. Bernanke has expressed a preference for the Commerce Department’s core inflation rate over the Labor Department’s core Consumer Price Index (CPI) measure and has given good reasons. But, though he frequently talks about inflation, he doesn’t talk about the Dallas Fed measure, despite its distinct advantages over its competitors. Since the Dallas core inflation rate has been running above the Commerce core rate for some time, perhaps the chairman doesn’t want to advertise that and worry markets or stoke inflation expectations. Whatever the reason, the chairman’s quiescence and uneven treatment are puzzling if not disturbing.

Whether openly discussed or not, the Fed chairman and members of the policymaking Federal Open Market Committee (FOMC) cannot help but be influenced by the recent Dallas Fed core inflation numbers. They’re alarming. The July Commerce and Fed inflation core inflation data are the last inflation numbers based on the preferred Commerce Department statistics that will be available before the next FOMC meeting on Sept. 20. The less preferred CPI core inflation rate (which also excludes all energy and food) will be released tomorrow, as will the Cleveland Fed’s alternative median CPI core inflation measure based on Labor Department price data.

Financial markets do not expect the Fed to raise interest rates again this year. But if the FOMC weights the Dallas Fed’s core inflation rate commensurate with its advantages over the cruder and less alarming Commerce Department core inflation data, it could mean an extra push toward the resumption of federal funds rate increases later this month or next.

Alfred Tella is former Georgetown University research professor of economics.

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