Felix Salmon has a very nice take on core vs headline inflation:

[I]t does seem clear that there is a significant and positive gap emerging between headline inflation (which includes food and energy prices) and core inflation (which strips them out). The gap is essentially a tax on poverty.

The poor spend a much larger percentage of their income on food and energy than the rich do, and they don’t benefit much from large drops in microprocessor prices. If this gap is sustained going forwards, then the real income of the poor is going to be eroded by inflation much more quickly than the real income of the rich. Not that there’s much the poor can do about it. The rich, on the other hand, have the Federal Reserve on their side, since the Fed targets the core inflation rate.

Combine this analysis with the Fed’s particular vigilance against rising wage costs (the only thing that helps poorer people get richer) and you might wonder whether the Fed is a beneficent, technocratic manager of monetary policy, or a covert agent of class warfare against the poor.

OK. That’s a bit much. There are very good reasons for stripping out food and energy prices out of inflation measures, and paying special attention to wages. Inflation is bad not because some particular price level is ideal, but because some prices are sticky. A rapidly changing general price level will leave many prices glued to non-equilibrium values, impairing price signals in the economy and harming efficiency. Food and energy are not stripped out just because they are volatile. (There are lots of techniques for smoothing or averaging time series. Trimmed means and medians can be used to get a smoother view of distinct monthly datapoints.) Food and energy are left out of the core because their prices are not sticky, so price changes in these sectors are unlikely to distort the real economy.

Similarly, wages are particularly sticky, and can almost never go down in nominal terms. When wages rise above equilibrium levels, the Fed finds itself between a rock and a hard place. If it maintains price stability, overpriced wage levels exert a drag on the real economy. To get the economy chugging at full potential, the Fed will have to “accommodate” some inflation to bring wages back down in real terms. But a jump in the price-level may create self-fulfilling inflation expectations among workers and firms, leading to a “wage-price spiral” that is hard to slow down once it gets going. It’s better for everyone, therefore, if the Fed is diligent about not letting wages get ahead of themselves to begin with.

That’s all well and good. But aren’t house prices downward-sticky too? There are indeed very good reasons for the Fed to pay less attention to food and energy, and very much attention to wage levels.

But isn’t it odd that right and proper theory somehow requires that the Fed to tilt the playing field towards capital and the already wealthy, and to fight any increase in the bargaining power of people who neither speculate nor to borrow, but who work every day and live off the proceeds?

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Note: I’m pretty sure I first read the justification outlined above for stripping food and energy from core measures somewhere on David Altig’s excellent macroblog. I can’t find the specific post, but alotta love to him anyway. (It’s possible, since I can’t find the post, that I’m misattributing this argument to Altig. If I am, sincere apologies, but good vibes anyway for his very thoughtful blog.)

Update: It looks like the argument about stripping food and energy from core inflation may have been cribbed from Mark Thoma rather than David Altig. All the brilliant econobloggers kind of look the same to me. Anyway, see this post by Mark Thoma.

This entry was posted on Friday, June 15th, 2007 at 9:10 pm PDT.
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