Core vs Headline Inflation

As reported in the New York Times, Fed Chairman Ben Bernanke is being asked by Congress about his methods of trying to stimulate growth in the US economy. Already we have seen two major bouts of quantitative easing – QE1 and QE2. However, some members of Congress believe that Bernanke is not focusing enough on inflation or the prospect of inflationary pressures. However as pointed out by Paul Krugman it depends on what measurement of inflation you use. There are two measurements:

Headline – It is inflation that measures the rate at which the cost of living is rising. It is headline inflation relative to income growth that determines whether a household’s standard of living is rising or falling.

Core – For the purpose of measuring monetary policy, however, the Fed and many economists focus more intently on the core rate of inflation: the total excluding food and energy prices. In part, that is because the core is less volatile and a better reflection of the interplay of supply and demand in domestic product markets. Thus, the core usually is a better gauge of the underling rate of inflation that will tend to emerge in the absence of supply shocks.

Below is a clip from Reuters showing Ben Bernanke defending his policies before a congressional committee, saying that inflation isn’t the problem but unemployment is still too high, and that the central bank remains committed to its $600 billion stimulus program.

The thinking behind the Fed’s belief in core inflation is that a one-time surge in commodity prices is not a reason to tighten monetary policy (raising interest rates). The graph below shows the core inflation rate at a very low level and non-threatening. The real issues in the US economy are the slow pace of growth and high unemployment figures.

Leave a Reply

Your email address will not be published. Required fields are marked *