Yet another CPI report was released on Friday, and quite a few people are reading the same report with different conclusions…

CPI “proper” indicated a 2.7% rate of price increases… While the Core CPI rate indicated a 0.1% rate of price increases. Those that look at CPI think that inflation is ramping up, and those that look at the core rate think that inflation is under control.

Sidebar: one important point is that prices do not inflation make — inflation is a monetary phenomenon (a change in the money supply), and price changes are a visible side-effect (with a lag) of the monetary inflation. We’re playing a guessing game looking at prices and thinking that prices “are” inflation.

The inflationist camp will argue that the 0.1% core rate was rounded down from 0.149%, which is a true and convenient talking point, but they’re missing a much bigger problem.

What is the Core CPI? According to

CPI can be greatly influenced in any given month by a movement in volatile food and energy prices. Therefore, it is important to look at CPI excluding food and energy, commonly called the “core rate” of inflation.

The general argument here is that the prices in energy and food fluctuate too much, and using them makes it hard to see the real trend. I agree — food and energy fluctuate violently, and make it hard to understand what the real trend is.

Let me make a comparison to my personal finances. My credit card bills fluctuate quite a bit month to month. Some months I pay for 6 months of car insurance, or a weekend trip to another city, or some other “one-time” expense. The credit card amounts are volatile, and as such, I want to exclude them when looking at my financial well-being. I’ll remove the credit card amounts from my cash flow, which I will refer to as my Core CFI (Cash Flow Index). If I do this, I never have a down month, and in fact my finances are always improving and always under control.

So, the other day I went into a bank and asked for a loan. To prove I was a good credit risk, I showed my banker my Core CFI, and explained to him how my bottom line is always getting better, and I’ve never spent more money than I earn in any single month. Do you think that the banker approved my loan? If so, I have some land in Florida to sell you…

Excluding food and energy completely is a significant mistake, and one that masks the true effects of price changes. If food and energy are too volatile in their monthly changes, then we should have an Adjusted Core CPI, which would include smoothed values for food and energy — this could be in the form of a moving average, a seasonally adjusted weighted average, or other similar measures. Such a methodology would still be flawed, but we’re trying to be precise about an imprecise measure, so I consider it a wash and think it would improve upon on the current Core CPI.

As it is, the Core CPI simply throws out food and energy all together, claiming that they never matter, not even when we look at the changes in prices over a long period of time. Food is weighted at 15% of the CPI, Energy contributes 8.7% — if we exclude the two of them for Core CPI, then the CPI is determined using only 77% of the items in the index.

There are also some good reasons to consider using a Trimmed Mean PCE, which would provide a good alternative.

Incidentally, you can see the raw data here, and the Core CPI-U, the Core CPI for urban dwellers, went up 2.2%… so those of us who live in cities didn’t benefit from a low Core CPI — even when you exclude food and energy.

Sidebar #2: The focus on Core CFI (or Core CPI) is very similar to the pro-rata earnings that were so popular only a few years ago.? Let me exclude “one-time charges” that make things look less exciting, and overstate my earnings potential…