Thursday, May 17, 2007

Inflation View

Barry Ritholtz has done a couple of posts on inflation. He has the opinion, (of which I share), that the government is grossly understating inflation. By stripping out food and energy while massaging the other measures, the government reports no longer reflect real life, understating inflation.

In an attempt to understand a more accurate inflation picture, Barry suggests this:

One way to actually measure how absurd the US core inflation measure is to look at what has happened to the spread between headline CPI and Core CPI. If Core CPI is understating inflation, than the spread should be widening. If it is accurate, the overall ratio between the two should be relatively steady.
Historically the Fed has stripped out food and energy because they were "volatile", meaning wide swings up and down. The "core" rate was supposed to give a clearer picture of the underlying pattern of inflation. But what happens if those volatile measures have an upward trend? It seems to me that, even though volatile, a trend upward suggests a bunch of inflation.

This chart provided via Barry shows the percentage spread between the Fed's core inflation and the overall "headline" number:

As I think is clearly shown by the chart, the spread between the core rate and the overall rate is on a steady march upwards and nearing levels not seen since the 1970's.

Other countries are starting to look at inflation in different terms ..... and starting to worry about it. I wonder how long it will take the Fed to recognize that there's a problem? The motivation to continue to ignore inflation is strong, i.e. they don't want to have to raise interest rates while the economy is slowing. But unless inflation is gotten under control, the defacto taxation of inflation will result in much worse economic consequences than a temporary recession.

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