Measuring core inflation

The Washington Times ^ | July 28, 2004 | Alfred Tella

[neverdem]

The Washington Times
www.washingtontimes.com

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Measuring core inflation

By Alfred Tella
Published July 28, 2004

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When the Consumer Price Index is reported every month, the media highlight two numbers: the change in the total index and the change in core prices. The traditional measure of core inflation excludes from the total the volatile components of food and energy. In June, seasonally adjusted core prices for all urban consumers rose 0.1 percent, following a 0.2 increase in May. This was widely interpreted to mean underlying inflation had cooled.

    But did it? An alternative and in many respects preferred measure of core inflation says otherwise.

     First some background. Measures of core inflation attempt to discern the underlying trend in consumer prices and as such are important to economic policymakers, notably the Federal Reserve, as well as to investors and consumers themselves. In the overall index, trends are often obscured by temporary or erratic fluctuations in some components, which has led economists to devise measures to eliminate the "noise" and capture the longer-term movement of prices. A measure that reveals the underlying trend in consumer prices serves as an important predictor of future inflation.

     Economists have criticized the traditional measure of core inflation on the grounds excluding food and energy throws out useful signals with the noise. The excluded components constitute a substantial part of the total price index and can exhibit trend movements of their own, not just temporary fluctuations. Moreover, other price components in the traditional core measure are often more volatile than food and energy. If reducing short-term volatility is the aim, there are better ways to do it.

     An argument for the traditional measure is that food and energy prices are subject to supply shocks, such as droughts and production cutbacks by oil cartels, and so should be excluded. This makes the index more relevant for monetary policy, it is argued, since the Federal Reserve has its impact on the economy mainly through its influence on aggregate demand. Critics reply not all food and energy price changes are the result of supply shocks and that other prices included in the traditional measure are also subject to supply disturbances.

     Proponents of the traditional core measure also argue it's well known and accepted and that its simplicity makes it more readily understandable by the public. However, it's not necessary to sacrifice accuracy for transparency and an alternative core measure need not be complex.

     Among the alternative core inflation measures proposed and tested by economists, two in particular stand out. One measure trims the Consumer Price Index to exclude a specified percentage of extreme positive and negative monthly price changes. The particular components excluded may vary each month. The resulting core measure is called a trimmed mean index. Even though it does not exclude the same components every month, as the traditional core measure does, the trimmed mean index still tosses out potentially useful information on trend inflation.

[AZLiberty]

Conventional inflation (or deflation) is monetary, measured by how much additional money the government "prints" (or electronically puts into circulation). The market can produce higher or lower prices for products based on scarcity, as demonstrated by eggs going to $2 a dozen this spring and back down to $1 now. Technology generally produces lower prices by reducing the required inputs to produce the same or even better outputs. All of these are going on at the same time.

Greenspan's "genius", as I've said before, is to inflate the currency at roughly the same rate as technology is driving the general price level downward, producing an apparent inflation rate of approximately zero, and siphoning off huge amounts of money for government spending without requiring additional taxes. This is, in part, what makes the Bush tax cuts work: the government still gets its cut (by printing it), and people think they're paying less taxes. As long as technology continues to drive down the general price level, no one's the wiser. In fact, it behooves the government to support technology improvement, since the faster technology drives down real prices, the more the goverment can extract through monetary inflation without attracting anyone's attention.

[Once-Ler]

This is, in part, what makes the Bush tax cuts work: the government still gets its cut (by printing it), and people think they're paying less taxes.

So cutting taxes is just a ploy to give Government more money, and when I get a rate reduction in my income taxes I only think I'm paying less. That is friggin' brillent AZL. How do you do it?