Headline Vs. Core Inflation

[cloudhopper]

It is commonly said that central banks exclude food and energy prices from the total "headline" inflation rate because the remaining "core" inflation is the only aspect they have control over.

Why exactly is this true? It seems to me that if a central bank has loose monetary policy, as the US Fed has had recently, the value of the currency will fall and therefore the prices of (imported, at least) energy will rise. Also the cost of food production and delivery will necessarily rise with energy prices.

So it seems to me that monetary policy will affect these non-core prices even faster and more directly than the core items. Can anyone enlighten me on this topic?

[cclub75]

It is commonly said that central banks exclude food and energy prices from the total "headline" inflation rate because the remaining "core" inflation is the only aspect they have control over.

Why exactly is this true? It seems to me that if a central bank has loose monetary policy, as the US Fed has had recently, the value of the currency will fall and therefore the prices of (imported, at least) energy will rise. Also the cost of food production and delivery will necessarily rise with energy prices.

So it seems to me that monetary policy will affect these non-core prices even faster and more directly than the core items. Can anyone enlighten me on this topic?

It's not really a matter of control.

The idea behind the Core CPI (that excludes food and energy) is that food and energy are volatiles.

They can increase a lot a month (weather, crops blablabla) and decrease a lot the next month.

Now this idea has been very convenient for years... for the central banks in the world, to understate the real inflation. It was perfect. The perfect trick.

But a black swan came suddendly : food and energy are not volatile ANYMORE. Their prices just went up... continue to do so... and will continue to do so.

This is why now the Core CPI is nothing but a headless chicken running amok. And certainly it will be the grave of the central banks.

Wait for the moment when you'll have a CPI headline of 20 %, with protests everywhere against prices of oil etc. and a Core CPI of 2,5 % and the jerks (Bernanke, Trichet and basically all the central bankers) will tell the world very seriously that inflation is not a problem !

It has started already.

As for your other questions, it's very complex. I just want to say that the value of the currency is just one factor of the equation (USD going down, everybody understand that the US will import inflation by importing oil for instance).

But... there is also the demand factor. Food, basic commodities, raw materials (iron, steel etc.).... they are all lifted by demand, globally (we have of course exceptions).

Think about just one idea : demography.

The figures change, but overall, we forecast a global population of 9 billions people by 2040 (versus 6.5 now). Now ask yourself : this huge population growth, is it inflationary or deflationary ?

For that matter, do you seriously believe that "Core CPI" will have any meaning in the future ?

[of course this is just a theory... I mean if you think that oil prices will go back at 20 USD per barrel (or even 50), then no problem... "Core CPI" will survive ]

Edited June 26, 2008 by cclub75

[cloudhopper]

Thanks CC. I certainly agree that that the rampant population growth we have been experiencing will drive the demand side (not to mention being the root cause of just about all of the major world problems) but why will core inflation increasingly lag headline so much under the scenario you suggest?

[cclub75]

Thanks CC. I certainly agree that that the rampant population growth we have been experiencing will drive the demand side (not to mention being the root cause of just about all of the major world problems) but why will core inflation increasingly lag headline so much under the scenario you suggest?

First point

Well, you're right : there is a lag (but that's new).

(here the banksters disagree : because energy-food are volatile, their prices will of course go down, so we won't have, never, spillover effects... into the Core CPI. That's was the PC version, for many years).

(When I wrote "20 % for headline and 2,5 % for core" it was of course a parable.)

Now, iron ore goes into steel, steel goes into cars, construction etc... Oil goes into... everything (from transports, to chemicals, fertilizers... food etc.) etc.

So we see clearly that the strong increase in prices of basic commodities, raw materials etc... had and will have a domino effect into many sectors, goods and services.

I'm not sure however we can say that the lag is increasing. Because before, there was no point to have a lag (roughly : oil goes up ? No problem CPI headline goes up... Core CPI remains... then oil goes down... CPI H goes down... Core CPI remains etc.)

I prefer to speak about the "gap". The "gap" starts to appear now (because CPI headline... doesn't go down, but goes only upward, and very quickly [oil was at 100 USD in january... 140 now !]).

And after the "gap"... right... you have a "lag" (time for the spillovers or secondary inflationary effects to contaminate the Core CPI). Businesses always take more time to change their prices, to adjust.

Second point

Let's not forget that meanwhile, we had and still have powerfull deflationary forces. Everybody know for instance that prices of LCD TV screens... were divided by 2 in 2007 ! These appliances have some statistical traces into the CPIH but also in CCPI.

Along with its products, China exported everywhere deflation too.

Third point

The way the gvt calculate CPIH and CCPI played a big role too in lag, gap... If a computer costs 100 in Year 1, and 100 Year 2 but with a larger hardisk... then they consider that the prices of this computer... actually decreased because for the same price you get... better (hedonic method). It's very convenient and powerfull (and of course nobody bother to notice that actually... you don't have choice : every computer come with a larger HD)

Fourth point

We have to repeat over and over that CPI (headline and core) is a FUNDAMENTAL piece of data.

-Government use it to adjust pensions, and calculate many other money flows

-central banks use it to adjust their monetary policy (let's mimic bernanke : "Wouah CPI is at +0,001 % ! Great ! Therefore, I don't need to increase my interest rates ! The party can continue ! " )

-CPI is used to calculate GDP in real terms (GDP is another big piece of data that allow the gvt to shout very proudly "we had a growth of X % this year, compare to the previous year !" (calculations of growth GDP, year on year, are of course made with real GDP [constant prices], not nominal GDP).

The CPI is a very important item of the virtual reality that they have created.

Fifth point

This is why what we are living is fascinating... because people are totally lost ! The situation is fundamentally new.

Well, actually I think we start to wake up... but 2007 was really amazing : people were fighting over inflation/deflation, etc. And were confused with many contradictory stats, figures, surveys.

Anyway. Again this is a only hypothesis with a basic idea : what was volatile (up/down) becomes unidirectional (up).

Many people disagree with that (still).

[by the way... new record of oil, intraday, in NY : 140,30 USD per barrel... oops ! Allez, let's pray for the oil going back at 50 )

Edited June 26, 2008 by cclub75

[LivinLOS]

Cant trust any of them.. all hedonically adjusted to make them essentially false signals.

Go read john williams's shadow stats.. Great info resource.

[PeaceBlondie]

cclub75 nailed it on his first post. Volatile elements of a group of numbers can be overlooked if they are as likely to go back down as to continue going up (and, can be ignored if they are tiny parts of the weighted sample, which food and energy are not). But these two elements are not going to go down, and they are far too important to be ignored.

Whether or not there is peak oil, the cheap and easy oil is already burned. Good topsoil has been washed away, used up, or paved over. The green revolution of the past is unlikely to be repeated, and the new babies will be just as hungry, while whole regions of the earth develop expensive tastes for grain-fed beef and ethanol fuels. And nobody even tries to find a long-term use for used nuclear waste.

[lannarebirth]

The headline vs. core inflation disparity doesn't bother me too much, as you have to smooth that data somehow. Eventually higher food and fuel costs work their way into core inflation statistics. It's the hedonic calculatons that really undermine the inflation index. Hedonics is used to make a lot of assumptions which are for the most part bullshit.

[cloudhopper]

Good stuff ...thanks. Looks like we're living in interesting times!

BTW I can't find a definition for "hedonic". ??

[lannarebirth]

Good stuff ...thanks. Looks like we're living in interesting times!

BTW I can't find a definition for "hedonic". ??

Hedonics is an adjustment applied based on a change in pleasure or quality. Lots to digest here:

http://www.google.com/search?q=cpi+hedonic...amp;startPage=1

[cloudhopper]

Hedonics is an adjustment applied based on a change in pleasure or quality. Lots to digest here:

OK thanks I get it now - we're getting better oil.