The Federal Reserve's open market committee opted to stop raising the federal funds rate, leaving it at 5.25 percent for the time being. This was no surprise on Wall Street, unlike additional bad news about oil and natural gas, yet it unleashed a barrage of editorial criticism from such leading conservative papers as The Washington Times and The Wall Street Journal.

The Fed's critics make it sound as though the past three months have revealed an enormous spike in "core" inflation (excluding direct energy expenses and, unimportantly, food). On Aug. 2, a Wall Street Journal report said, "The price index for personal consumption expenditures excluding food and energy (PCE) ... rose 2.4 percent in June compared with a year earlier, matching the fastest annual rate since 1995." Comparing the second quarter to the first, that same core PCE index was said to have increased "at a 2.9 percent annual rate, the fastest pace in more than a decade."

The Fed statement remarked that "readings on core inflation have been elevated in recent months," yet predicted that "inflation pressures seem likely to moderate" as a result of past monetary tightening. Contrary to Fed critics, the phrase "baked in the cake" refers to lags between actions and effects, not only to excessively easy policy in 2003.

In reality, the core PCE index rose at the same 0.2 percent pace in April, May and June, leaving only March "elevated" at 0.3 percent. Monthly increases also averaged 0.2 percent during the first quarter and during the last quarter of 2005.

Martin Feldstein's recent Wall Street Journal article worried that "the doubling of the price of oil is being reflected in transportation costs and in the costs of goods that use petrochemical inputs." But all of those indirect energy expenses are included in the core PCE deflator, which is nonetheless still rising at a fairly routine 0.2 percent monthly pace. Prices of oil and natural gas cannot rise forever, and when they stop rising, that 0.2 percent monthly rate (2.4 percent a year) is all that will be left, minus today's elevated costs for transportation and petrochemicals.

Why are these unchanged 0.2 percent monthly increases now being described as the fastest since 1995 when they have not changed since last August? This mass hallucination results from statistical pitfalls involving comparing price indexes from year to year and multiplying quarter-to-quarter changes by four to fabricate an "annual rate."

The reason the year-to-year core PCE deflator appeared to increase from 2 percent to 2.4 percent over the past three months had nothing to do with faster inflation this year. It had to do with unusually slow inflation last summer -- just 0.1 percent from June to August. That pulled the year-to-year figure down from 2.3 percent in November 2004 to as low as 2 percent for a while, and it made last summer a tough act to beat on any year-to-year comparison. If the increases stick to the 0.2 percent monthly routine, the year-to-year percentage changes will look better this fall because core inflation was back to normal last fall. These year-to-year gains have fluctuated up and down between 2.0 and 2.4 percent for 27 months.

What about expressing quarter-to-quarter changes at an annual rate? On that basis, core inflation looked like 1.6 percent in the third quarter of 2005, yet I recall no front-page stories about how inflation had suddenly returned to the "deflation" levels of 2003. The first quarter of 2006 included one low 0.1 percent increase in February, so the quarter-to-quarter rate appeared to drop to 2 percent, from 2.5 percent in the fourth quarter. That created an artificially low base for the second quarter, which appeared to be 0.713 percent higher than the first -- the so-called 2.9 percent annual rate. Yet nobody dared to claim the annualized figures of 1.6 percent or 2 percent were proof of a new inflation trend, so why believe that only when the number looks higher?

Monthly increases in the core PCE index averaged 0.2 percent in all of the past three quarters, briefly touching 0.3 percent only in October 2005 and March 2006. The market-based core PCE index, which is less reliant on estimates, is up 2 percent over the past year. The similar chain-weighted CPI (which is not seasonally adjusted) increased by 0.1 percent in May and June. There is no evidence of "elevated" inflation in recent months from any chain-weighted index that excludes direct energy expenses.

But suppose we really are suffering the fastest core inflation "since 1995." What did the Fed do about this supposedly horrific inflation back then? It reduced the fed funds rate from 5.6 percent in December 1995 to 5.3 percent in December 1996 and 4.7 percent by December 1998. Continued...