Why the Federal Reserve Isn't Worried About Inflation Yet

The Fed focuses on core inflation, which strips out food and energy prices.

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If you haven't noticed it at the gas pump, you've seen it in the grocery store. The prices of some products, most notably food and oil, are going up.

In March, the Consumer Price Index (CPI), which measures the average change in prices over time of goods and services, rose 0.5 percent. The CPI is 2.7 percent higher than it was a year ago. That growth has been driven primarily by energy and food prices. The CPI's gasoline index rose 5.6 last month and has increased 14.4 percent over the last three months. This seems like cause for concern, right?

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Not if you're the Federal Reserve. The Fed remains undeterred about the prospect of higher food and energy prices, because it focuses on core inflation, which strips out food and energy prices. Core inflation rose only 0.1 percent in March, and over the last year, it has increased just 1.2 percent. The Fed sees core inflation as a better predictor of prices over the long term. "Over time, [the Consumer Price Index] is really volatile, and it tends to converge back to core, and core sort of moves like molasses," says Jeffrey Cleveland, senior economist at money management firm Payden & Rygel. "Historically, [core inflation] has been a good gauge of where prices will end up."

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Critics blame higher food and energy prices on Fed policy. The Fed has kept interest rates at virtually zero since December 2008, and has initiated a controversial second round of quantitative easing in which it is buying $600 billion worth of treasury securities in hopes of pushing rates even lower to help spur economic activity.

"The government is frequently out of touch with what mainstream consumers are experiencing," says Madeline Schnapp, director of macroeconomic research at TrimTabs Investment Research. Schnapp is concerned that higher food and gas prices will cause a slowdown in consumer spending. In March, the Fed said food and energy prices are volatile at times, and not a cause for concern just yet. In its statement, the Fed said: "The recent increases in the prices of energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory."

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Oil price shocks come and go, says Stacey Schreft, former economist and vice president at the Kansas City Federal Reserve. She points to the last major oil price shock that began in February 2007 and lasted for a record 17 months, during which crude oil hit a record $145 per barrel. During that period, the core inflation rate remained fairly stable. For now, "Unless the nature of the current oil price spike changes substantially, there is no reason to expect a rise in core inflation," says Schreft, who is now director of investment strategy at The Mutual Fund Store, an investment firm.

While food and gas prices are probably the most visible sign of higher prices because consumers notice them on a daily or weekly basis, there are other prices that aren't rising as quickly. Prices of some items that are considered more discretionary have fallen. For instance, the CPI's apparel index fell 0.5 percent and March, and the household furnishings index fell 0.1 percent. "When consumers pay more for food and energy products, they cut back on discretionary spending, like spending on furniture, clothing, and recreational activities, which pushes the prices of those goods down," Schreft says.

Twitter: @benbaden


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