Jeffrey M. Lacker

English

Research Papers in Economics

R
ecent increases in commodity and energy prices
mean that Americans are paying more at the
grocery store and at the gas pump — at the same
time that many families are still trying to regain their
footing after the recession. In this environment, it is under-
standable to ask why many economists, including those
within the Federal Reserve System, frequently seem 
to focus on “core” inflation, which excludes often volatile
food and energy prices, rather than on “headline” 
inflation, which does include those items that are so 
important to households. In fact, from time to time I get
asked, don’t I buy food or gasoline? 
The answer is yes, indeed, I do. And I, as well as others
within the Federal Reserve System, pay attention to the
prices of those goods — both when we purchase them and
also when we consider monetary policy. In fact, the Fed’s
mandate is to ensure the long-term stability of the overall
price level, which means that headline inflation is our 
ultimate concern. 
But in the short term, we must be careful that the tools
of monetary policy — which have a lagged effect on the
economy — are not applied in reaction to temporary price
changes. The level of core inflation is not a goal in and of
itself; rather, it is a means to the end of determining the
most appropriate policies for the long run.  
That said, core inflation is not a perfect predictor of
underlying inflation trends, and its correlation with overall
inflation may depend on how it is measured. Moreover,
recent research suggests that looking only at core inflation
may understate the decline in purchasing power actually
experienced by households during previous periods.  
The two most common measures of inflation are the
consumer price index (CPI) and the personal consumption
expenditures (PCE) price index. I tend to prefer the PCE
measure, which is based on data from the CPI but includes
different weighting methods that make it more consistent
over time. Since 2000, the PCE has also been the preferred
measure used by the Federal Open Market Committee
(FOMC). 
Because inflation numbers often run hot or cold for 
several months at a time, the Richmond Fed looks closely at
year-over-year headline PCE inflation to evaluate economic
conditions in the Fifth District and the nation. Headline
inflation is also an important component of the longer-term
economic forecast each Reserve Bank president prepares
prior to FOMC meetings. That does not mean, however,
that core projections aren’t useful too. All members of the
Committee evaluate those measures as well, especially when
looking at more near-term conditions.  
Currently, inflation forecasts are consistent with our
PRESIDENT’SMESSAGE
price stability mandate, and the
market’s expectations reflect
that commitment. But as I
noted in my last column in
Region Focus, signs that the
recovery is strengthening may
mean that we will need to exit
from our current accommoda-
tive monetary policy in the
near future. And upward pres-
sure on energy and commodity
prices must be monitored care-
fully. Monetary policymakers
cannot influence the relative price of oil, of course, but we
can and must keep a close eye on whether distributors begin
passing along higher input prices to consumers. If headline
changes prove to be more persistent than previously 
expected, we must be vigilant that they not become embed-
ded in expectations. 
The lesson to be drawn from this discussion is that no 
single measure of inflation is “wrong.” The Fed’s mandate
means that we should choose the best tools available to
determine the appropriate policies to achieve long-term 
stability of the overall price level. In short, we are committed
to fostering an economic environment in which households
and businesses can make the investment and savings 
decisions that will promote their well-being and the 
well-being of the nation’s economy as a whole. That means
taking into account the prices of all goods — including food
and energy —  when considering the likely path of inflation
and which policies we should pursue as a result of that 
evaluation.  RF
Don’t I Buy Food or Gasoline?
JEFFREY M. LACKER
PRESIDENT
FEDERAL RESERVE BANK OF RICHMOND
Region Focus | First Quarter | 2011  1

President's message : Don't I buy food or gasoline?

http://www.richmondfed.org/publications/research/region_focus/2011/q1/pdf/presidents_message.pdf

President's message : Don't I buy food or gasoline?

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Research Papers in Economics