INFLATION MEASURES IN THE UNITED STATES

The Federal Reserve Bank of the United States measures inflation using something called
the Core Personal Consumption Expenditure Index, or Core PCE Index. Core inflation
refers to the components of inflation that are more durable and not a result of temporary
events, such as a hurricane. Core inflation excludes food and energy prices, which vary
temporarily.
The PCE is now the favorite measure used by the Federal Reserve. However, in an attempt
to be even more accurate, economists have gone further and developed a trimmed
PCE, which is designed to give a truer view of inflation. Table 2.1 shows three measures
of PCE, but what is really important is to realize that any rate above 2 percent is considered
to be a signal of too much inflation in the economy by most central banks, and these
kind of levels lead to expectations of central banks’ increasing interest rates or at least
not decreasing rates.
The Producer Price Index (PPI) is another key measure that is reported and tracked.
The PPI measures what businesses charge one another for everything from iron ore
and diesel fuel to cases of soda pop. The U.S. Bureau of Labor Statistics generates PPI
data for over 8000 different product categories, reflecting price pressures among different
industries. A net PPI figure, of course, is more general in nature (www.bls.gov/). In
November 2006, the PPI surprisingly rose 2 percent higher than the month before. The
index had not risen by that much in a single month in more than 32 years, since the
energy and stagflation crises of the mid-1970s. The fact that the PPI and the core inflation
may differ adds to the uncertainty of the true condition of the economy regarding
inflation.
The Consumer Price Index (CPI) tracks consumer price changes given a fixed basket
of goods and is part of the data set watched by traders in all countries. The U.S. Bureau
of Labor Statistics provides comprehensive data on inflation and, in fact, tracks the various
inflation rates. It conducts extensive sampling of 87 urban areas, 50,000 homes, and
23,000 retail establishments. Persons interested in getting deeper into their methodology
for generating inflation data will be rewarded by going to the Bureau of Labor Statistics’
web site. From time to time, the CPI basket changes to more accurately reflect new items available in the economy. The problem with CPI is that it doesn’t reflect housing prices
and therefore may underreport inflationary pressures.
Tracking gold, the Commodity Research Bureau, and other commodity indexes and
patterns will also help you get a handle on inflation. We look at the commodity-currency
connection in Chapter 5. The main point here is that the forex trader needs to pay serious
attention to inflation rates and expectations of inflation rates, because they are a key to
discerning what the central banks fear, and a clue to whether they will raise interest
rates.


By ABE COFNAS