Is there a danger of inflation taking off? When the price of gasoline and food shoot through the roof, it seems like it. But central bank officials calmly comment that it makes more sense to focus on \”core inflation,\” which strips out energy and food prices, on the grounds that these prices fluctuate a relatively large amount, and thus give a distorted view of the inflation that is actually occurring. Of course, this leads a lot of distraught citizens to respond that they have to pay for energy and food, whether the central bank thinks that those prices are relevant or not.
\”On the topic of the volatility of headline inflation, the headline index can be smoothed in any number of other ways that stop short of ignoring a wide class of important prices in the economy. One simple way is to consider headline inflation measured from one year earlier, but there are many others. To the extent that the volatility of headline inflation is a problem, there are better methods of addressing that than to simply dismiss troublesome prices.\”
Liu and Justin Weidner In the 1960s through the 1980s, deviations of headline inflation from core seem to have been resolved by core inflation catching up with headline. For example, the two episodes of high headline inflation in the 1970s were followed by significant run-ups of core inflation. However, since the early 1990s, core inflation has remained stable despite fluctuations in headline. This observation is confirmed by empirical studies and formal statistical analysis showing that the behavior of inflation has substantially changed since the late 1980s and early 1990s …\” On the other side, Bullard sets a skeptical standard for such evidence: \”Suppose we have a full model of the inflation process, one that includes expected inflation, measures of real activity, and measures of the stance of monetary policy. We then add core inflation as a variable to this model and assess the marginal predictive value of core inflation given all other variables. If the marginal value of adding core inflation in this context is positive, one might then have a claim that core inflation contains some “special” information over and above information coming from the rest of the economy concerning the future course of inflation. I have not seen convincing evidence of this type.\”
One might also reasonably question the “temporary” characterization of the shift in energy and other global commodity prices. It is certainly true that we should not expect energy prices to increase faster than the general price level without limit. But it is also true that there are wellknown
examples of long-term secular trends in certain prices. One example is medical care prices, which for decades have generally increased faster than the headline CPI index. Another example is computing technology, where prices have more or less continuously declined per unit of computing power, even as other prices have continued to rise. So it is possible—and indeed it does happen—that whole sectors of the economy experience relative price change.\”