This commentary was written by Dr. Daniel Thornton of D.L. Thornton Economics. Thornton spent over three decades at the St. Louis Fed as vice president and economic advisor.
In several previous essays I have written, here, here, here and here, I have argued that no one, especially the Fed, should look at core inflation for two reasons.
The first and foremost is the fact that no one cares about core inflation unless, of course, you don’t eat and don’t drive a car.
The second is that core inflation has been shown not to be a better predictor of headline inflation than headline inflation. In spite of this fact, some policymakers and others still believe that the core measure provides information about the future headline measure.
The figure below demonstrates that this was certainly not the case during the Great Inflation from 1965 to 1985. The figure shows the headline and core measures of CPI inflation over the period.
The figure shows that more often than not the two series move together. Moreover, there are periods when one moves before the other. Changes in the headline measure tend to lead changes in the core measure, but the relationship is quite weak.
Hence, during this period there is no compelling evidence that one leads the other, which of course is a necessary condition for predictability.
The figure also shows that there are several instances when both measures decline only to increase and go above the previous high. Consequently, you might not want to get too excited when one or the other measure declines or increases. Such behavior may not portend where the inflation rate will ultimately go.
Finally, the average inflation rates of the two series are nearly identical, 6% for headline inflation and 5.9% for the core measure.
This reflects the fact that while the headline measure is somewhat more volatile, on average they are affected by the same dynamic forces that determine the inflation rate.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor piece written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.
