...and finally, argument by unfounded assertion

It bothers a lot of people that food and energy are excluded from the inflation measure that is used by the Fed as a guide to policy.

It bothers Jayhawk:

So how did the “Trump tax cut” cause the decline in new home sales? Well, the tax cut caused runaway inflation, which we didn’t see but Dean Baker and the Federal Reserve did, when it soared to dizzying heights and got all the way up to 1.87% last year.

Never mind that the price of gasoline went up 74%, it’s all in how you measure things. Dean Baker and the Fed only measure the prices of things that people don’t buy. Food, energy and housing are not included, thus 1.87% inflation.

Yeah, it bothered me too. A lot. But I read something that rang a bell, and now it doesn't bother me at all. At least for now.

Randal K. Quarles:

Traditionally, as taught in Econ 101, inflation provides a signal on whether the economy is operating above or below its potential level. If inflation moves up in a sustained manner, not just because of temporary shocks, then the economy is likely operating above its productive capacity, as firms have the leeway to raise prices given the strength of demand.

Three things about that statement. First,

inflation provides a signal on whether the economy is operating above or below its potential

Yeah, okay, that's mainstream econ. The dumbed-down "Econ 101" version maybe, but mainstream. I have just one problem with it, which I'm saving for last.

Second,

If inflation moves up in a sustained manner, not just because of temporary shocks, then the economy is likely operating above its productive capacity...

Just the way Quarles said it, I get it: if inflation moves in a sustained manner, not because of temporary shocks. The Fed is looking for evidence of sustained inflation, not for evidence of brief disturbances. They're looking at the trend, not the jiggies. It makes good sense.

I think that's probably a good way to set policy. But I don't think it's a particularly good way to measure the inflation that affects us as consumers, or whatever we call ourselves. I'm still with Jayhawk on that. If the price of gasoline went up 74% because of some "shock", we still had to pay the higher price. The cost of living includes it all, you know? Even food and gasoline.

So I figured I'd make a graph comparing the PCE Price Index with, and without, those "shock" categories. And then it got interesting:

Graph #1: PCE Price Index including (red) and omitting (blue) Food and Energy Costs

Moving together in 2012 and 2013, the two datasets separated in 2014. And since that time, the one that includes food and energy has been lower. So, by this measure anyway, leaving out food and energy shocks makes the price index higher. I can't tell you why, but that's what the graph shows.

I need another look. A second graph. This time, showing the index that omits food and energy, relative to the index that includes them:

Graph #2: Excluding Food and Energy, relative to Including Food and Energy

If "shocks" to food and energy prices were pushing the rate of inflation up, then the index that doesn't count them would be lower than the one that does. But the index that doesn't count the shocks is higher, since 2014.

So the Fed is using the higher measure of inflation as a guide to policy. Not the lower measure. And you really cannot say what Jayhawk seems to imply, that they're excluding food and energy to reduce the calculated rate of inflation.


"...and finally, argument by unfounded assertion"

Getting back now to what Randal Quarles said, there is one more point I have to make.

If inflation moves up in a sustained manner, not just because of temporary shocks, then the economy is likely operating above its productive capacity, as firms have the leeway to raise prices given the strength of demand.

If there is a sustained increase in inflation, Quarles says, it is because of the strength of demand. In other words, all inflation is demand-pull.