Is Inflation Under Control?

by: James Picerno

The academic literature is long and deep in favoring core inflation as a superior predictor of headline inflation. By that reasoning, the recent dip in core indices gives hope to the prospect that the Federal Reserve has contained the beast.

As the chart below shows, the Fed's preferred measure of inflation (the price index for core rate of change in personal consumption expenditures) is showing signs of behaving lately.

PCE chart

But as we discussed last week, there's still plenty of anxiety about inflationary trends, in part driven by the rise in headline gauges. In fact, the anxiety that springs from the conflicting signals of headline vs. core has been front and center in debates within the Fed. Thursday's release of the minutes from the FOMC meeting of June 27-28 details the worries in the meeting's conversations, as the following excerpt reveals:

The incoming data on core consumer prices were viewed as favorable, but were not seen as convincing evidence that the recent moderation of core inflation would be sustained. Participants noted that monthly data on consumer prices are noisy, and recent readings on core inflation seemed to have been depressed by transitory factors. Moreover, a number of forces could sustain inflation pressures, including the generally high level of resource utilization, elevated energy and commodity prices, the decline in the exchange value of the dollar over recent quarters, and slower productivity growth. In addition, while core consumer price inflation had moderated of late, total consumer price inflation had moved substantially higher, boosted by rising energy and food prices. While total inflation was expected to slow toward the pace of core inflation over time, a number of participants noted that recent elevated readings posed some risk of a deterioration in inflation expectations. On this point, several participants cited the uptick in forward measures of inflation compensation over the intermeeting period derived from Treasury inflation-indexed securities. However, a portion of this increase might be attributed to technical factors, and survey measures of long-term inflation expectations had held steady over recent weeks. Nonetheless, several participants emphasized that holding long-run inflation expectations at or below current levels would likely be necessary for core inflation to moderate as expected over coming quarters.

The voices worrying about inflation are all the more timely with oil prices rallying anew, perhaps to a new all-time high in the near future. The question then becomes whether the public thinks inflationary pressures are on the rise. If the answer is "yes," then the fear may become a self-fulfilling prophecy. After all, there's a lot of consumers out there paying more for food, and energy who are behind the times when it comes to reading the academic literature on core.

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