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Economy in Brief

The Report in Brief. Food prices surged +0.8%) and energy jumped +0.9%, but the core held at a 0.2% gain. Still the Yr/Yr core at 2.7% remains lofty and a 2.6% the three month trend is not much better; Year-to-date core inflation is up by 3%. - So much for showing signs of progress. Recreation costs came down to flat this month but that series has been subdued. Transportation was up by just 0.1%; that was mostly weak vehicle prices. Housing costs pushed higher by 0.4% in the month as owner equivalent rent rose by 0.3%. Apparel was up by 0.5%. Medical care ‘slipped’ to +0.5% after rising by 0.8% in January. Core goods prices rose by 0.1%. Core services prices rose by 0.3% Core goods prices are flat year-over-year. Core services prices are up at a 3.8% Pace Yr/yr. Upshot? International competition is doing little to tame the inflation pressure in the services sector.There is Something About Inflation. Let’s begin by defining the familiar to better understand it. Inflation is a persisting rise in the price level. That explains everyday life in the modern economy. We live with inflation. The real question is, ‘when is inflation ‘excessive?’  The Fed has offered some guide posts. These guideposts are not formalized; they are not ‘targets’ (non-targets). But the Fed members refer to a range that is a ‘comfort zone.’ This range consists of inflation of 1% to 2%. The percentages refer to annual rates for inflation, usually taken to mean Yr/Yr rates. The numbers refer to the PCE deflator with the CPI‘s range residing about 0.4% points higher from 1.4% to 2.4%. But in truth since Dec 2004 the average gap between the two core inflation measures has a much smaller 0.2% points.  If something wacky hits headline inflation like a surge in oil prices the Fed applies the rule to the core as it is doing now.  Apart from looking at the true headline and core the Fed does not look at any other inflation measure with any special factor taken out: it’s headline or its core.

The Fear of all Sums

Next I have a table that summarizes what inflation is doing. This table centers in on the ONLY TWO CPI measures that matter, the headline and the core. In this table we look for momentum by calculating growth in the CPI over various time spans (3-mo 6-mo 1-Yr and the previous 1-year period). Next we inspect what we could call the internals of inflation. For this I delve through the Haver data on the CPI categories and assess inflation at the component level.We do this for various inflation horizons as mentioned above, assess if inflation is the same, higher or lower. From these categories we create sums. Form these sums, we construction inflation diffusion indicators at each horizon. Thus we get several looks at inflation from the same data set, a sort of consistency check. We can gauge if 3-mo inflation is higher than 6-mo inflation denoting an acceleration and then see if inflation is rising across most of the time dependent categories to produce that result or not. If inflation were to accelerate, but if diffusion were to drop, we might conclude that the acceleration is spurious. In that case the aggregate acceleration might result from a few ‘high-weight categories in the CPI but not be a property of prices in general. In that case we might urge the view that the rise in CPI pace does not represent an acceleration in inflation at all.

Diffusion acts as a double check on the trend. The CPI is after all whatever it is (the existential view). It is a product of the items in the basket and weights used for them and periods over which inflation is assessed.  But inflation may be different from what the CPI does. We use the diffusion measure to ask not if the rise in the index is authentic (of course it is) but rather if the TREND it sketches is true in the sense of stemming from broad based patterns within the CPI itself. That gets at the notion of sustainability, a necessary property for a rise in the CPI index to be deemed inflation.
Fact and Opinion Economics Proprietary Diffusion Readings: CPI & Its Core
Total: 56 categories Detailed Diffusion By Various Horizons:  
Total CPI   One Mo.   3-Mos.   6-Mos.   1-Yr.
CPI SAAR   4.5%   4.0%   0.0%   2.4%
% Accelerating   0.57   0.70   0.54   0.53
% Unchanged   0.00   0.00   0.00   0.00
% Decelerating   0.43   0.30   0.46   0.47
Total Diffusion Gauge   0.57   0.70   0.54   0.53
Core: 35 Categories Diffusion trends are low: (values below .50 are good)  
Core CPI   One Mo.   3-Mos.   6-Mos.   1-Yr.
Core CPI SAAR   2.9%   2.6%   2.2%   2.7%
% Accelerating   0.57   0.60   0.40   0.57
% Unchanged   0.00   0.00   0.00   0.00
% Decelerating   0.43   0.40   0.60   0.43
Core Diffusion Gauge   0.57   0.60   0.40   0.57
Diffusion: 1-mo is vs 1-mo ago; 3-Mo is vs 3-Mo; ago 6-Mo is vs 6-Mo; ago 12-Mo is vs 12-Mo ago
Detailed diffusion measures over various horizons        
What we find this month IS DISTURBING on those growths, First of call core inflation is disturbingly rising from 2.2% over six months to 2.5% over three months to 2.9% (Feb SAAR). The Yr/Yr pace is 2.7%. Moreover, the CORE diffusion readings are 40 for 6-mos, 60 for 3mos and 57 for one month. A value over 50 shows inflation is accelerating in more categories than it decelerating.  For Yr/YR core CPI diffusion is 57. That means that we find inflation’s trend is accelerating at the core level AND we find that most components within the Core CPI are showing the same tendency toward acceleration that we see in the headline. Sure the move up is mild. The pace itself is mild but the pace is OVER THE FED’S OWN SELF-IMPOSED SPEED LIMIT, or guideline we should day.Speeding? Central Banker:  Ticket thyself!So does the Fed obey its own rules on inflation? Not really - sort of. This is policy in the making and like sausage the result is better enjoyed than the process discussed...nonetheless:The Process As you know the Fed has a dual mandate for sustaining growth and containing inflation. Plus, as we assess the Fed, any sort of judgment may span more than one Fed leader - whose ways do change. Still the 2% inflation threshold is like the Holy Grail for central bankers. The Bank of England uses it and the ECB uses 2% as its ceiling. The Fed uses it as the top of its comfort zone (for the PCE) but sort of transforms it to 2.4% for the CPI due to ‘distortions’ (don’t ask, don’t tell – at least not now).
Under Greenspan the Fed surely did cut interest rates with the CPI Core well over this top rate for inflation ( see chart above). Of course, at the time the economy and industrial production were declining rapidly. Although the Fed was uncomfortable doing so, when the core CPI  fell below 1.4% the Fed cut interest rates further. But when the pace of the core CPI got back to 2% the Fed began raising rates (all this was Greenspan). With the CPI core between 2% and 2.4% the Fed continued to hike rates. Bernanke took over at the Fed and continued this process then stopped with the Funds rate at 5.25% in July of 2006. But inflation did not stop accelerating. It continued to accelerate then it decelerated mildly a few months later and now has a three observation uptrend in place once again and the Fed is still holding rates steady with inflation STILL, for eight straight months, over the top of its range.As you can see the Fed’s policy non-target is a simple thing. But making policy involves more than just this bare target framework. For now inflation’s momentum is going the wrong way and diffusion tells us that the acceleration is widespread and therefore likely to continue. With the economy still struggling the Fed has a difficult choice to make.     Never get comfortable thinking that policy can be as simple as the Feds own expression of a simple policy comfort zone.
Consumer Prices: 2007 February Report
Overview: Excess remains moderation in question
Quick Summary         Year-To-Date One Mo. Mo/Mo
  Yr/Yr 6-Mo a.r 3-Mo a.r   2007 2006 Diffusion Feb.2007
CPI 2.4% 0.1% 4.0%   3.3% 4.0% 57.1 NOT
Core CPI 2.7% 2.2% 2.6%   3.0% 2.1% 57.1 Annualized
Commodity Category Mo. ar   Annualized Inflation Rate For Last:  
By Expenditure Category Feb.2007 % Wgt 3-Mos   6-Mos.   Year Month
All Items 4.5% 100.00 4.0% 0.1% 2.4% 0.4%
Food and Beverages 9.8% 16.20 5.9%   4.1%   3.1% 0.8%
Housing 4.8% 39.98 4.2%   3.6%   3.3% 0.4%
Apparel & Upkeep 6.4% 4.45 4.1%   1.9%   2.1% 0.5%
Transportation 0.6% 17.57 3.8%   -13.3%   -0.5% 0.1%
Medical care 5.9% 5.81 6.0%   4.6%   4.3% 0.5%
Recreation -0.1% 5.91 -0.9%   0.4%   1.6% -0.3%
Education & Communication 4.1% 5.31 1.5%   5.9%   5.1% 0.7%
Other Goods & Services 2.6% 4.77 6.8%   5.0%   3.6% 0.2%
By Industry Group
Nondurables (NSA) 3.2% 31.26 4.7%   -3.8%   1.9% 0.3%
Durables -1.3% 10.57 -2.8%   -3.4%   -1.8% -0.1%
Services 4.7% 58.17 4.3%   3.7%   3.4% 0.4%
By Economic Group
All Excl Food & Energy 2.9% 77.10 2.6%   2.2%   2.7% 0.2%
(Median Increase) 4.2% 100.00 4.1%   3.6%   2.3% 0.3%
Excl. Energy 4.0% 92.32 3.1%   2.4%   2.8% 0.3%
Commodities: Excl Food & Energy 1.0% 22.77 0.7% (29% of core) -0.9%   0.0% 0.1%
Services: Excl Energy 3.7% 54.33 3.5% (71% of core) 3.5%   3.8% 0.3%
Core less Tobacco #N/A   #N/A   #N/A   #N/A #N/A
Food & Energy
Energy 3.8% 7.68 15.3%   -36.4%   -1.3% 0.3%
Food 9.8% 15.22 6.1%   4.1%   3.1% 0.8%
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