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Stepping Back and Looking at the History of Core Inflation

Wed, Aug 20 2008, 22:44 GMT
by Asha Bangalore

Northern Trust

Stepping Back and Looking at the History of Core Inflation

The July price reports – wholesale, retail, and import – have raised a number of questions about the underlying threat from inflation. Stepping back in time and looking at historical data should help us understand the big picture. Inflation is a lagging economic indicator which peaks after an economic downturn has commenced and establishes a trough several months after a recession has ended and the next recovery is underway.

Food and energy prices are out of the reach of monetary policy changes in the short-term, so I chose to focus on core price measures. Moreover, oil and other commodity prices have been trending down in recent days. Chart 2 plots a short history of the core consumer price index and core personal consumption expenditure price index. Both core price measures show a rising trend in the last few months and the latest year-to-year readings exceed the Fed’s comfort level.

Tables 1 and 2 present the behavior of core prices through business cycle since 1960. The main conclusion is that both core price measures – core CPI and core personal consumption expenditure price index – peak several months after the peak of the business cycle. In particular, the core CPI and core personal consumption expenditure price index peaked eight months after the peak of the last expansion in March 2001.

Therefore, where is the U.S. economy at the moment? The NBER has yet to date the peak of the current business cycle. The four measures the agency uses to date business cycles have peaked. Our best guess is that the peak of the current cycle is December 2007/January 2008 or approximately around this time period. In other words, if history is a guide, the U.S. economy is probably at the brink of a turning point in inflation. This is entirely conceivable given the projection of weak economic conditions in the near term. Inflation expectations (as measured by the difference in nominal 10-year U.S Treasury note yield and the 10-year TIP yield) as of August 19 stood at 2.15%, down from 2.57% on July 3.

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Published on  Wed, Aug 20 2008, 22:48 GMT