Everyone is worried about if and when the Federal Reserve will raise interest rates, even though the Fed itself continues to say that it is not considering doing so. The personal finance strategy Catch-22 here is that as soon as the Fed drops the language in its statement saying that they plan to leave interest rates unchanged for the near future, markets will react as if the Fed actually raised rates. That is what happens when interest rates are so low (basically just above zero) that everyone knows the only way they can go is up.
Recent inflation data about the Consumer Price Index, or CPI was released suggesting that inflation remains calm if not non-existent.
Consumer prices in the U.S. fell 0.1% on a seasonally adjusted basis in April as energy, housing, auto and apparel prices declined. The core CPI — which excludes food and energy prices — was unchanged in April, lowering the year-over-year increase in core inflation to 0.9%, the lowest rate since January 1966. – MarketWatch
What is Core Inflation or Core CPI
I find it ironic that with every news story published about the CPI there comes an in text explanation of what the "Core CPI" is. The single liner typically says, as above, that the Core CPI excludes food and energy prices. The irony is that the same news story makes no effort to explain what the Consumer Price Index is in the first place, so how much sense does it make to explain what is excluded from it to derive the Core CPI?
In other words, do you what price categories are included in the CPI? How much help is it then to know that the Core CPI does not include two of the categories from the original list that you don’t have? I’m just saying.
The Bureau of Labor Statistics calculates and releases numerous price indexes. The one that the media constantly refer to as The consumer price index or CPI is actually the All Items Consumer Price Index for All Urban Consumers for the U.S. Cities Average, 1982-84=100. This is abbreviated CPI-U. As you can see, there is actually a lot that goes into the number reported as CPI.
Components of Consumer Price Index CPI
The basket of goods measured by the BLS to compute CPI is actually very large. The main categories, as reported by the BLS, are:
- FOOD AND BEVERAGES
- HOUSING
- APPAREL
- TRANSPORTATION
- MEDICAL CARE
- RECREATION
- EDUCATION AND COMMUNICATION
- OTHER GOODS AND SERVICES
As you can see, the CPI measures a lot more than just your average everyday expenses. Some categories, such as Medical Care and Education affect certain people a lot more than others.
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The Core CPI that the media likes to report about is officially known as All items less food and energy. You can tell from its title what the BLS thinks about this particular statistic. Nonetheless, the idea is that Food and Energy prices are particularly volatile and by excluding them one gets a better idea of what the "real" inflation is. Whether that is true or not depends in large part to what extent the increase in food or energy prices are part of a long-term trend versus short-term adjustments, much like day-to-day stock market prices.
Raw CPI data is virtually worthless, which is why the Fed takes into account many more factors to put the CPI index into context when making its rate setting decisions. In other words, it is best not to get caught up in the hoopla surrounding individual CPI numbers. However, keeping an eye over time on the statistic provides a thumbnail sketch of whether prices are rising or falling.
For now, the concern is not the CPI and the CPI will not be an important factor in the Federal Reserve’s interest rate policy in the near future. Right now, the Fed’s only concern is how to withdraw the extra stimulus it has provided to the economy through its unprecedented steps in 2008 and 2009 without causing the fragile recovery to collapse. Everything else is just background noise.