Eat the Core, Never Mind the Apple

A very bad habit began in early 2000. In February of that year the Federal Reserve Bank, then under Alan Greenspan, abandoned the Consumer Price Index (CPI), produced by the Bureau of Labor Statistics, as the basis for measuring inflation in the economy. Instead it substituted the Personal Consumption Expenditures index, produced by the Bureau of Economic Analysis. Now, mind you, the PCE is based on the CPI. It’s not a free-standing anything. No CPI, no PCE either. But the PCE modifies the results of the CPI by using a somewhat different formula. Underlying it is an assumption that when prices go up people will shift their purchasing to another product. Now the PCE comes in two varieties: the total PCE and then the so-called core PCE. The core excludes food and energy—these two being viewed as volatile and seasonal.

Let’s think about this. Food prices are rising. Now, based on PCE thinking, I’m going to substitute some other purchase for my purchases of food. Right? Obvious, isn’t it? I’ll go on vacation and not eat at all. Or, alternatively, gas prices are rising. Economic rationalist that I am, a true believer in the PCE, I will therefore stop driving. My thirty-mile commute can be accomplished on a bicycle, of course. And just imagine the health care benefits!

Or better yet! CPI is rising. But so, alas, is PCE. But I am a Federal Reserve Banker. When the economy goes south, I feel a lot of heat on my backside. So why don’t I give up both? I’ll give up both food and energy purchases. I’ll just live on the core of the apple. I didn’t like all that sweet moist stuff anyway—juices always dripping down and messing up my striped-blue suit. Thank the Lord there is the core PCE. I can not only use it in all of my measurements but above all in every one of my public statements.

Now here’s an added complication. The PCE is published quarterly, the CPI monthly. And since the PCE reflects the CPI (indeed can’t exist without it) everybody and his brother still uses the CPI to talk about inflation. They just exclude two categories from it. They exclude food and energy. That leaves the core, doesn’t it. And thus we get the phrase, “core inflation.” Now, best of all, CPI is rising, but the core of it isn’t, or only faintly. Thus those of us who feel the heat from the public can pronounce that all is well. The core’s in good shape—even if the apple’s rotting.

The graphic you see puts all this into a picture. I show monthly changes in CPI by three categories since July of 2010. Whatever prices were in July, that’s what they were. I call that 100. The bars show changes in price from that level. Lo and behold. Food prices are up 1.9 percent in this seven-month period, energy prices up a whopping 14.8 percent, and the rest—that’s the core, folks—is up less than 1 percent (0.7% actually). The data I am using may be found here.

Food and energy are the apple. The rest is what, in a real pinch, we can mostly do without. But our leaders are wise. They know that we will believe what they say, not what they do.