Two Measures Of Inflation And Fed Policy – Thursday, August 30

Note: The charts below have been updated with the latest Personal Consumption Expenditures price index from the Bureau of Economic Analysis. The annualized rate of change is calculated to two decimal places for more precision in the side-by-side comparison with the Consumer Price Index.

The BEA’s Core Personal Consumption Expenditures Chain-type Price Index for July, released this morning, shows that core inflation remains below the Federal Reserve’s 2% long-term target at 1.99%. The most recent Core Consumer Price Index release, also data through July, is higher at 2.35%. The Fed is on record as using Core PCE data as its primary inflation gauge.

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee’s ability to promote maximum employment in the face of significant economic disturbances. [Source] Note: bolding added.

Elsewhere the Fed stresses the importance of longer-term inflation patterns, the likelihood of persistence and the importance of “core” inflation (less food and energy). Why the emphasis on core inflation? Here is an excerpt from one of the Fed FAQs.

Finally, policymakers examine a variety of “core” inflation measures to help identify inflation trends. The most common type of core inflation measures excludes items that tend to go up and down in price dramatically or often, like food and energy items. For those items, a large price change in one period does not necessarily tend to be followed by another large change in the same direction in the following period. Although food and energy make up an important part of the budget for most households — and policymakers ultimately seek to stabilize overall consumer prices — core inflation measures that leave out items with volatile prices can be useful in assessing inflation trends. [Source]