Joe Queenan on core inflation

In a very entertaining piece in this weekend’s Wall Street Journal, Joe Queenen gripes about how economists measure inflation.

He starts by lamenting the high cost of everything from gas, to bagels, to coffee.  “You can imagine my surprise,” he continues, “when the latest economic data came out and we were told that inflation wasn’t much of a problem at all. The price index for core personal consumption expenditures increased a piddling 0.9% from the previous year, keeping the national inflation rate far, far below what economists see as the danger level.”

He then goes on a riff–similar to one I often hear from my aunt (who constructs her own price index on the basis of a few key produce items when she goes shopping)–suggesting that excluding things so basic and so widely consumed as food and fuel from the “core” consumer price index  is, well, “…baffling. Removing fuel and food costs from the index purely for the sake of statistical balance seems a bit like saying, ‘All told, four million people died in World War II. Well, unless you include the people who died in concentration camps. And, oh yeah, the 20 million Russians. It’s a bit like saying, ‘On average, a major league baseball team will win 3.2 World Series each century. Obviously, not the Cubs. And we’ve thrown out the New York Yankees and their 27 world championships because it doesn’t provide a true snapshot of the game at any given moment.'”

That entertaining–presumably tongue-in-cheek–description will resonate with many people, including my students, so let me set the record straight.

Consumer prices can rise for macroeconomic reasons or microeconomic reasons.  Macroeconomic reasons include increases in consumer, government, or foreign demand, or excessively expansionary monetary policy.  These forces tend to affect prices across the board.  Microeconomic forces, including a price spike in oil due to unrest in the Middle East or an increase the price of tomatoes because of bad weather, tend to be more narrowly focused, affecting only a few prices.

There is no doubt that consumers feel both effects equally, but there are good reasons for policy makers to view them differently.  Price increases due to macroeconomic forces require a macroeconomic policy response, such as tighter monetary and/or fiscal policies.  Price increases due to microeconomic forces are fundamentally different.  Food and fuel markets are inherently volatile and, like the weather in New England, may change if you wait a bit.   Further, there is not much that policy makers can do about fluctuation in these markets.  Or, as Fed Chairman Ben Bernanke pointed out at his news conference, the Fed does not control the oil market.

The same can be said of the tomato market.