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Sunday, October 30, 2011

The CPI Food and Energy Debate

Occasionally I see something that annoys me so much that I feel the need to respond to it in a blog post.  Today, it was that I saw people on a message board saying that the Consumer Price Index (CPI) no longer includes food and energy so you shouldn't pay attention to it.  There are some legitimate criticisms of how CPI is calculated, but this isn't one of them.  The headline CPI number does include food and energy, but economists are usually more interested in the so-called "core" CPI rate, or the change in prices excluding food and energy.  The reason that they prefer this measure is that it isn't as driven by possibly arbitrary changes in commodity prices.  If inflation is truly endemic, it will show up in less volatile prices because wages are likely also inflating at a rapid rate, pushing up the prices of more stable goods as well as services.

Some have also wondered if over time the two come out more or less the same.  After all, according to some, inflation and food and energy is always faster than other prices so if you follow core inflation only you are missing the story.  Well, not really:

For most of the years after 1981, core CPI actually outpaced total CPI because energy and food prices were quite sedate while health care costs went through the roof.  Since the mid 1990s, however, it is true that total CPI has outpaced core inflation.  In fact, the compounded annual growth rate (CAGR) of total CPI vs core CPI has been 0.5% a year higher than core inflation since September 2000.  Still, what history would suggest is that these two will not diverge by a great deal for that long.

Now, as to the volatility, adding food and energy does add a great deal of volatility.  The average monthly inflation rate of both measures over the past 54 years is about 0.32%, but the standard deviation for the total CPI is a full 0.06% higher than for the core CPI.  It might not sound like a lot, but it does matter.

So no, there isn't some evil conspiracy behind excluding food and energy.  In truth, I look at both anyway as alternative measurements.  It doesn't take too long and there isn't much harm in doing it.

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