- The Washington Times - Saturday, January 27, 2007

On Jan. 18, the Bureau of Labor Statistics (BLS) released its report on the consumer price index (CPI) for December with apparently heartening news about inflation.

After accelerating during the first three quarters of 2006, core inflation (measured by the CPI excluding energy and food prices, which tend to be volatile and obscure the underlying trend in overall prices) slowed in the final three months of the year.

This improvement was presumably due to Federal Reserve policy. The good news about inflation was widely reported in the media. Still, members of the Fed’s policymaking Federal Open Market Committee (FOMC) continue to say the main inflation risk is to the upside.

Though Fed officials favor the tamer (and less timely) inflation numbers from the national economic accounts as reported by the Commerce Department, they also closely watch the BLS consumer price data. The Federal Reserve system also produces its own measures of core inflation, notably a median CPI calculated each month by the Federal Reserve Bank of Cleveland that has been telling a different story than the BLS core index.

The traditional measure of core CPI inflation, which the BLS reports, excludes all energy and food prices from the overall index. It’s a crude technique that throws out some nonvolatile items within the energy and food categories that can carry a valid signal of underlying inflation. It also retains other items that may be “noisy” and obscure the underlying trend. The Cleveland Fed’s median CPI gets around these problems by taking another approach. It derives a weighted median index that excludes much of the noise in the BLS micro data and zeroes in on the more stable midpoint of the distribution of monthly price changes.

The Cleveland Fed’s median CPI is based on the work of Michael Bryan, a vice president and economist at the Cleveland bank, and Stephen Cecchetti, an economics professor at Brandeis University. A thorough evaluation of the median CPI and its performance was made by the Cleveland Fed before it decided to adopt the measure and calculate and report it monthly on its Web site. To illustrate the bank’s confidence in the data, the heading on one of its permanent Web pages reads: “Median CPI provides better measure of core inflation.” Analysis showed the weighted median CPI was more closely correlated with past money growth than competing core inflation measures and yielded improved inflation forecasts.

When compared with the traditional CPI core measure, the preferred median price data are disquieting.

The year-over-year change in the BLS core CPI for all urban consumers rose from 2.1 percent at the beginning of last year to a peak of 2.9 percent in September, then eased to 2.6 percent in December. By comparison, the 12-month change in the median CPI was 2.5 percent at the start of 2006 and increased throughout the year, reaching 3.7 percent in November and December. There were even directional inconsistencies. In October and November the annual change in the BLS measure declined while the Fed measure rose. Though the BLS reported underlying inflation slowing in the fourth quarter, the Cleveland Fed’s index showed faster-rising core inflation.

In the final months of 2005 the year-over-year change in the median CPI was 0.3 percentage point higher than the BLS core measure. That difference rose to 0.4 point in January-February 2006, to 0.6 point in May-September, to 0.9 point in October, and to 1.1 percentage point in November and December. According to the better Fed measure of core price change, underlying inflation has accelerated by more than the Labor Department, the administration and the oblivious media would have us believe.

Some economists believe the CPI measure is upward biased. But even if as much as a half or three-quarters of a point were shaved off the latest 3.7 percent median inflation rate, the year-over-year increase would still be an elevated 3 percent.

Press, TV and Internet coverage of the CPI rarely mention the Fed’s core inflation numbers. The media need to get their act together. It’s important that the public be fully informed. As consumers, investors, business people and workers, we act according to what we know and what we’re told.

We make financial decisions based on our own economic circumstances, but we’re also influenced by what we’re told about national trends. What we observe and what’s reported about recent inflation trends help form our expectations about future inflation and the economy. If we’re not told about some of the best inflation numbers available, especially numbers that carry a different message, we risk making costly financial mistakes.

Alfred Tella is a former Georgetown University research professor of economics.

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