Tuesday, August 16, 2005

A perfect example of the "core inflation" deception

I recently wrote a article explaining why the so-called core inflation rate is a nonsensical concept. In it I pointed to how it is often the case that while the all-items index come in higher than expected while the "core" rate mysteriously come in lower than expected and how this strangely is met with cheers and a bond rally. The reason for the higher than expected all-items index and the lower than expected core index tend to be the same: namely higher energy prices. Higher energy prices will raise the all-items index, but lower the core index both indirectly through the effect of reduced purchasing power for consumers and directly through the calculation of homoeowner's equivalent rent which is calculated by checking the level of rent and then assume that this is the "implicit rent" paid by home owners. However, home owner's rent is deducted by fuel costs since tenants aren't assumed to pay fuel and in the absurd logic of the U.S. government this means that unless rents are instantly raised (which they rarely are), implicit rent for home owners are decreased with the same amount as their fuel costs are increased. Even though home owners in the real world don't get any cost cuts to cancel out the increased fuel costs , this is what the CPI and PCE deflator indexes assume.

The latest CPI report was a perfect example of this. The CNN Money article on it announces in its headline that there was a "mixed reading" with all-items up more than expected and core up less than expected. And if you look at the specifics you see that rent was up 0.3% but home owners equivalent rent up only 0.2% no doubt reflecting the increase in fuel costs.

And with the nonsensical (Nonsensical from the point of view of the Fed. Given the Feds stance however it makes sense for the bond market to also do so, since it is ultimately the Fed that controls interest rates) focus on the core index, bond prices predictably rallied .


Blogger iceberg said...

I've made mention of you here:

Please let me know what you think.

10:53 PM  

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