Total and Core U.S. Inflation

June 15, 2011

U.S. core consumer price inflation, which excludes food and energy, was still fairly tame at 1.5% in the year to May.  Such was more than double the low of 0.6% in the year to October 2010 but below the 1.8% rate of increase in the year to May 2009, which encompassed the severest part of the recession.

Headline total CPI inflation, on the other hand, had accelerated to a clearly uncomfortable 3.6% by last month from 1.5% as recently as December.  Consumer prices had contracted 1.3% in the year to May 2009 and risen 2.0% in the next sequential year to May 2010, so a pattern of acceleration has persisted.

The Federal Reserve, like the Bank of Japan, pays most attention to core inflation than an index that includes every item.  The European Central Bank, in contrast, watches total inflation most closely than core.  A policy that stabilizes core inflation hopes to avoid over-steering policy by responding to commodity price shocks that are often related to non-domestic factors and not sensitive to changes in credit policy.  Additional justification for a policy anchored by core inflation lies in the assumption that core inflation will approximate total inflation in the long term.  Over the final thirty years of the last century, that is between December 1969 and December 1999, total U.S. consumer prices climbed at an annualized rate of 5.113%, while core CPI inflation averaged 5.150%.

The tendency for core and headline U.S. inflation to equate over the long run has broken down more recently.  During the ten years to May 2011, headline and core inflation averaged 2.432% and 1.928% per annum respectively, and those rates of increase over the last five years were 2.217% and 1.718%.  These discrepancies of a half percentage point per annum support the contention that commodity prices are behaving fundamentally different from before.  A long-term secular uptrend of commodity costs is now in place related to the rapid growth of global population and development of emerging economies, and this mustn’t be disregarded by policy-makers.  The old presumption that commodity prices may be volatile but that swings are evenly distributed around zero seems flawed.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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