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August 28, 2006
Crabbing About Core
The Bank of England's Charles Bean had some negative things to say about core inflation at this year's edition of the Kansas City Fed's annual Jackson Hole thinkfest -- comments duly noted by Daniel Gross, by Mark Thoma, and by Michael Kowlaski -- but he was not the only one taking potshots at the core concept this weekend. William Safire -- the New York Times' wordsmithing maven -- had some complaints of his own:
The man whose words are parsed more closely than anybody else’s in the world opined in early June to a bunch of bankers that this year’s “core inflation” — setting aside volatile food and gas prices — “has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability.”
Ben Bernanke, current chairman of the Federal Reserve, in a written sentence that he must have sweated over for a week. I think his point was that inflation may be getting too high (in which case it would be inconsistent with price stability), and so I ran his words past Floyd Norris of The Times, a practiced Fedspeak cryptologist. “What bugged me most about the sentence is its reliance on ‘core’ inflation,” noted my colleague. “Using the core figure for very short periods of a few months may make sense as a way to avoid meaningless volatility, but using it for six months or even longer is hard to understand.”
Even harder to understand is why economists have picked up a vogue word in politics — every “power base” now boasts a “core constituency” — and are using it to modify “inflation.” It is a word with beautiful poetic associations, from Shakespeare’s “I will wear him in my heart’s core, ay, in my heart of heart” to Keats’s “A virgin purest lipp’d, yet in the lore/Of love deep learned to the red heart’s core.” Now here it is qualifying the rising cost of living. “The ‘core inflation’ rate,” Norris says, “is relevant for those who neither eat nor use energy.”
I don't know about that poetry stuff, but in conflating "core" with "cost of living", I think Mr. Safire gets exactly the wrong idea. My colleague Mike Bryan explains it this way:
In theory, cost-of-living changes are measured by envisioning the cost of attaining a certain level of welfare and comparing that cost in different places or different periods of time. Unfortunately, “welfare” is impossible to quantify and a more practical approach is to calculate the cost of a representative market basket of goods and services and compare that cost between two places (like Cleveland and New York) or two periods of time (like 1960 and today)...
Many of the problems identified with the CPI (and other similar market basket approaches) have been well known to economists for nearly a century. Most arise because the basket of goods and services used to compute the cost-of-living statistic gradually becomes dissimilar to the basket of goods and services actually purchased by consumers... But another problem is that market basket statistics also pick up inflation because they measure the money cost of the basket. That is, the CPI can rise even if the cost of living is constant if the Federal Reserve continues to oversupply money and makes the dollar an increasingly inflated measure of cost.
Price statistics that attempt to isolate the persistent rise in the general price level are commonly called core (or underlying) inflation statistics...
An alternative procedure for measuring core inflation is to reconstruct the market basket in a way that reduces the influence of transitory price fluctuations originating in various components of the index. The idea here is that although such price swings may reflect changes in the cost of living, they are not part of a persistent rise in the general price level that comes from a monetary source. The best-known core inflation statistic excludes food and energy goods from the consumer market basket...
... By excluding some components of the market basket, the measure no longer reflects consumer spending patterns and therefore fails to qualify, in a meaningful sense, as a cost-of-living statistic; volatile or not, food and energy are important to our cost of living.
But it may be a useful signal of the underlying rate of change in the purchasing power of money, which -- speaking for myself -- seems like just the right idea.
UPDATE: Greg Mankiw opines:
This is yet another reason to think that for the foreseeable future the Bernanke Fed's commitment to inflation targeting is likely to be vague and informal. Monetary policy will remain more discretionary than rule-based.
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