Saturday, March 12, 2011

Core versus "populist" inflation

The Wall St. Journal and Reuters reported on NYFRB President William Dudley's remarks about total versus core inflation (core is total excluding food and energy) in a Q&A session after his prepared remarks at a meeting of the Queens Chamber of Commerce and Queens Economic Development Corporation in Flushing. Dudley made the mistake of referencing the iPad 2, which the food-price conscious in the audience didn't appreciate.

My experience teaching macro at Queens College suggests that at least among college students, there is a general perception that the rate of price inflation never falls, and furthermore that prices never fall. I attribute some of this to the large portion of budget spent on rent here in NYC, where rent control and stabilization policies will typically prevent rents from ever falling. But I'm not sure whether people internalize how food and energy prices go down as well as up.

To be sure, central banks aim for a target rate of core inflation around 2 or 3 percent, so prices typically rise rather than fall. But we haven't done a very good job explaining why the target needs to be positive, nor why it should be core rather than total inflation.

Ironically, I'd say Dudley explained himself fairly well in his remarks, but probably not in a way that made sense to his audience:

[E]ven if commodity price pressures were to prove persistent, they have a smaller impact in the United States than they do in many other countries. Relative to most other major economies, the U.S. inflation rate is lower, the amount of slack much greater and commodities represent a relatively small share of our consumption basket. This small share helps to explain why the “pass-through” of commodity prices into core measures of inflation has been very low in the United States for several decades.

Thus, while rising commodity prices may be giving some of you a bad headache, they are not likely to lead to a sustained rise in inflation to levels inconsistent with our dual mandate. We will have to ensure, however, that these pressures do not cause inflation expectations to become unanchored.