Thursday, June 16, 2011

Core Inflation Is A Lagging Indicator

Tim Duy's Fed Watch writes

Core-CPI gained 0.3% in May, likely sending shivers down the spines of hawkishly inclined FOMC members.  This was predictable – the gains in headline-inflation were certain to translate into a temporary rise in the core numbers,

That gains in "headline" (all items) inflation precedes (or in other words predicts) changes  in "core inflation"  rather than the other way around is something that I've pointed out for years. The reason for why this is the case is that "core" prices are usually less flexible and more sticky, meaning that increased inflationary pressures will first be evident in food and energy prices, and only later in "core" prices.

But the funny thing here is that the official justification for looking at "core" CPI is that it predicts all-items inflation. Yet as Duy now concedes, and as data have long shown, it is the other way around and the only thing "core" CPI shows is what inflationary pressures was in the past.


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