September 5, 2007 – Is inflation really subsiding? The Federal Reserve maintains that it is, but a visit to the supermarket, gas station or restaurant tells another story. The cost of living is anything but subsiding. Food inflation is rising at the fastest pace in 17 years, oil is over $75 per barrel, and gasoline prices are near all-time highs. Clearly there is a growing disconnect between what the consumer sees and what the Fed sees as inflation.
The Fed conducts monetary policy based on how core inflation is behaving. Core inflation excludes food and energy because historically these two items were impacted by short-term events like weather and temporary spikes in supply or demand. The Fed does not want short term events to effect monetary policy and rightly so.
But these days, food and energy costs have been rising because of fundamental changes in those commodities. Corn is being affected by the demand for ethanol, and in turn affects prices of meat, cereals and other foods. In addition, energy and metals are being affected by Chinese demand, not American demand. Neither are short term, and both are structural changes to the way we will be living for years to come.
The exclusion of all food and energy from consumer inflation data may not make much sense any longer as Americans continue to lose purchasing power while the Fed announces that core inflation is stable.
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