Are Inflation Fears Overblown?

Although some observers still think the Fed’s easy monetary policy risks a rise in the US inflation rate, there was scant fuel for their fears in the September inflation report from the Bureau of Labor Statistics. The all-items CPI for urban consumers rose at a seasonally adjusted annual rate of 3.7% in September, down almost a point from the August rate of 4.6%.

Food and energy prices are highly volatile and account for much of the month to month variation in the CPI. Their effect can be removed by taking food and energy out of the CPI. The result is called the core inflation rate, which fell to just 0.6% in September (monthly change stated as annual rate), the slowest for the year. Because food and energy prices contributed more than their share to inflation, as they have for most of the year, the core inflation rate was below the all-items rate.

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Another way to remove volatility from the CPI is the 16% trimmed mean CPI, published by the Federal Reserve Bank of Cleveland. The trimmed mean CPI removes the 8% of prices that increase most and the 8% that increase least in each month, whether they are food, energy, or something else. In September, trimmed mean inflation slowed significantly, although it remained above the core inflation rate.

No one measure of inflation is best. The all-items CPI gives the most accurate picture of current changes in the cost of living for urban consumers. The core CPI and trimmed mean CPI give more accurate pictures of underlying trends. Economists at the Fed look closely at the core and trimmed mean CPIs to judge the effect of monetary policy. They pay less attention to the all-items CPI, which includes food and energy prices that are set on world markets, beyond direct control of monetary policy.

The Fed, unlike many central banks, does not set an explicit target for the rate of inflation. However, it has made it clear that it considers an inflation rate of around 2 percent, over a medium-term time horizon, to be consistent with its mandate to maintain price stability. Although inflation has increased from its extremely low levels of 2010, the September inflation data, on the whole, fall within a range that the Fed should not find alarming.

Ed Dolan is Wall St. Cheat Sheet’s in-house economics professor. He is the author of an acclaimed series of textbooks Introduction to Economics and Ed Dolan’s Econ Blog.

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