Alan Reynolds

When the March consumer price index showed a 0.6 percent rise for the month and 3.1 percent for the year, many claimed inflation had suddenly become a big problem the Fed will have to battle with a series of interest rate hikes.

 Those same people did not, however, argue the Fed should lower rates in January simply because the monthly CPI then rose by only 0.1 percent. Nobody should try to find inflation trends in such monthly wiggles. We should be watching for sustained changes in year-to-year inflation rates. And Fed governors should take greater care than they did in 1990 not to confuse energy prices with a general uptrend in other prices.

 Aside from energy, there has been no increase in inflation for at least three years. Take out energy, and CPI inflation over the past 12 months was just 2.4 percent -- lower than the 2.5 percent average of 1998-2002. Yet that 2.4 percent rate still overstates inflation, as the Boskin Commission explained in 1996. So, in 2000 the Fed began to focus on a chain-weighted price index for personal consumption expenditures (PCE). Such a chained index is superior to the fixed-weight CPI because people react to prices. If gas prices soar while food prices slow, people are likely to drive fewer miles and eat at home more often. By assuming they're driving just as much as before and eating out just as often, the CPI overstates the cost of living.

 The PCE index covers rural areas, not just urban consumers, and it assigns more weight to medical services than does the CPI, and less to housing and new cars. Yet a newer chain-weighted version of the CPI tells the same low-inflation story as the PCE deflator. Both PCE and CPI figures for "core" inflation exclude food as well as energy. That's misleading right now because food is not why the regular CPI exaggerates inflation. Over the past three months, the CPI for energy rose at a 21.1 percent annual rate, compared with 1.3 percent for food.

 For the year ending in February, the "core" PCE deflator was up only 1.6 percent. A comparable but preliminary chained CPI estimate was up only 1.9 percent in March. That latter measure is lower than it was even in December 2001, at the end of the recession (2.2 percent). It slowed to 1.9 percent in March 2002 -- the same as today -- yet energy prices were down by 10.9 percent and are now up by 11.6 percent. If we had a figure for the chained CPI less energy alone (rather than energy and food), that would be up about 2 percent over the past 12 months.

Alan Reynolds

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