20 April 2011 – Chart of the Week
Chart of the Week: Inflation By Any Other Name
At first glance, the inflation rate in the US appears to be quite different than in Europe. The Fed’s preferred measure is up just 0.9% from last year. The ECB’s measure is running at 2.7%, well above its mandate and was the trigger for the first hike in this cycle. However, appearances can be deceiving. The differences have less to do with the underlying price trends in the US and Europe than with how the price indexes are constructed.
In the US, the headline consumer price index is up 2.7%. Many economists prefer to strip out food and energy costs to get at the underlying trends, which puts the core CPI at 1.2%. The Fed’s preferred core measure is a broader index of personal consumption expenditures, the core PCE, which at 0.9% is above the recent historic lows of 0.7% posted in December but well below the Fed’s informal target of 2.0%. With that kind of data, a hike remains on the distant horizon.
In Europe, meanwhile, the ECB has an explicit target of keeping inflation below 2.0% as measured by the Harmonized Index of Consumer Prices. The March print of 2.7% was the fourth month in a row that inflation was above the target and prompted policymakers to hike rates despite the ongoing economic stresses in much of Europe.
The divergence in the data is largely a methodological artifact: Policymakers in the US and Europe are measuring different things. The core PCE strips out food and energy and it includes the cost of shelter, which has been a drag in the US. In contrast, Europe’s HICP keeps food and energy costs but excludes shelter, the reason being that the statisticians have been unable to devise a way to harmonize housing costs across the EU.
A few years ago, the US government constructed an experimental index that recalculates the consumer price index following the same methods used in the EU. The US HICP is currently up 3.3%, nearly quadruple the pace of the core PCE. If the Fed measured inflation the same way they do at the ECB, US rates might be going up too.
The core PCE is also out of sync with the rest of the world, with prices going up briskly everywhere from China to Canada to Brazil. Inside the US, producer prices and import prices are also heading up. Even other alternative core price measures show a sharper turn in the inflation trends, from the Cleveland Median CPI to the Atlanta Sticky CPI.
During the recession, US policymakers fought the specter of a deflationary spiral by bringing interest down to historic lows and then launched two rounds of quantitative easing. They have said they want to see inflation go higher before any policy tightening. It’s possible they already have it.
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