Warning: Declaration of action_plugin_safefnrecode::register(Doku_Event_Handler &$controller) should be compatible with DokuWiki_Action_Plugin::register($controller) in /home/public/dw/lib/plugins/safefnrecode/action.php on line 14

Warning: Declaration of action_plugin_blog::register(&$contr) should be compatible with DokuWiki_Action_Plugin::register($controller) in /home/public/dw/lib/plugins/blog/action.php on line 0

Warning: Declaration of action_plugin_blockquote::register(&$controller) should be compatible with DokuWiki_Action_Plugin::register($controller) in /home/public/dw/lib/plugins/blockquote/action.php on line 0

Warning: Declaration of action_plugin_include::register(&$controller) should be compatible with DokuWiki_Action_Plugin::register($controller) in /home/public/dw/lib/plugins/include/action.php on line 0

Warning: Declaration of action_plugin_popularity::register(&$controller) should be compatible with DokuWiki_Action_Plugin::register($controller) in /home/public/dw/lib/plugins/popularity/action.php on line 0

Warning: Declaration of action_plugin_redirect::register(&$controller) should be compatible with DokuWiki_Action_Plugin::register($controller) in /home/public/dw/lib/plugins/redirect/action.php on line 0

Warning: Declaration of action_plugin_captcha::register(&$controller) should be compatible with DokuWiki_Action_Plugin::register($controller) in /home/public/dw/lib/plugins/captcha/action.php on line 0

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656
Core inflation cannot remain out of line with headline inflation [ClearOnMoney]
Top

Site

About
Contact

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656
Sitemap

Profile

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656
Trace:
Core inflation cannot remain out of line with headline inflation

Reference

Main
Updates
Schedule

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656

Warning: preg_replace(): The /e modifier is no longer supported, use preg_replace_callback instead in /home/public/dw/inc/auth.php on line 656
Commentary

Core inflation cannot remain out of line with headline inflation

2 Jun 2011 by Jim Fickett.

Two prominent people have recently fallen into the fallacy of confusing high prices with high inflation rates. Although energy may now be permanently more expensive, it is not possible for energy inflation to remain significantly higher than inflation of other items.

In March Bill Gross of Pimco apparently thought that the long-term shift to globalization, and resulting commodity boom, could cause a permanent misalignment between core (less food and energy) and headline (all items) inflation. A long-term view of the data suggests otherwise.

On Wednesday Lorenzo Bini Smaghi, a member of the executive board of the European Central Bank, made an argument similar to that of Bill Gross.

for core inflation to be a good basis for forecasting headline inflation, the variations in the prices of agricultural and energy products have to be temporary, and should on average not differ from other prices. If that is not the case, core inflation is neither a good estimate of underlying inflation, nor a good forecast of future inflation. It is therefore a simple matter of looking to see if data series relating to the prices of agricultural and energy products meet these requirements, and then asking if the forecasting properties of the core inflation series are an improvement on headline inflation after all.

A check of the data since 1999 shows that, apart from the 2008-09 recession and a few months of 2002, headline inflation is always higher than that of core inflation, both in Europe and the US, with a cumulative difference over the past decade of about 6 per cent in the euro area and the US, and 9 per cent in the UK. The reason is simple. Since 1999, the global index of energy and raw materials prices has more than doubled, as has that of food prices. These increases have not been short-lived at all, but have had a lasting effect. …

Given these results, one may wonder why core inflation has caught on in recent years, and continues to be used so readily. The reason is simple. In the 1980s and 1990s, core inflation met the requirements above and was therefore a good way to forecast headline inflation. But a structural change has taken place over the past decade, in which strong growth in emerging countries has increased global demand for raw materials in an unprecedented way. In the absence of an equally rapid increase in supply, this has produced a lasting change in the terms of trade.

Since a second person of such prominence is now espousing this mistaken view, I thought it would be worthwhile to clarify a little further where the fallacy lies.

Here is a variant of a graph I've shown several times, with the annualized inflation rate in a 10-year moving window, for three variants of the CPI – all items, energy (because it is the single most volatile component), and all items less food and energy:

The point I made before is that core and headline inflation, when averaged over a 10-year window, rarely diverge by very much (currently by 0.5%) and, over the long term, they alternate taking the lead, with first one higher and then the other.

Naturally, when the rate of inflation for energy (not the price of energy) is very high, headline inflation averages a little higher than core inflation. The key mistake that Bini Smaghi makes is to confuse the price of food and energy with the inflation rate for food and energy. Yes, the increases in price, and hence changes in the terms of trade, have been durable, but very high inflation rates for commodities have been transitory.

The additional point I would like to make now is that headline inflation cannot, by mathematical necessity, remain significantly higher than core inflation for too long. Currently annual inflation of energy is running at 19.0%, while core inflation is running at 1.3%. Bini Smaghi seems to think this situation can persist. What would happen if this disparity continued for the long term, say 20 years? The price of energy would go up by a factor of 32, while prices not in the food and energy categories would go up by a factor of 1.29 (i.e. 29%). This is not possible, because energy is a component cost in almost everything. If gasoline were to rise by a factor of 32, to $128 per gallon, then transport costs, mining costs, wage costs, and factory operation costs would all go up very significantly, and services, steel, postage, and everything else would have to go up too.

So yes, energy can and will get more expensive. But the rate at which the cost of energy rises cannot, for the long term, remain much higher than the rate at which other prices rise. Sometime in the next few years, core inflation will catch up with headline inflation once more.