With “headline” consumer price inflation (CPI) at 4.3% for the last 12 months, we have now reached the inflation rate that spurred Richard Nixon to impose wage and price controls on Aug. 15, 1971. The controls were certainly the wrong remedy, but the intuition that such a high inflation rate cannot long be tolerated was correct.
Nixon acted because the inflation rate, though declining, remained stubbornly above 4%. What has changed to render 4% inflation tolerable today?
Nothing for those who earn, spend and save the dollar. What is different today is that the Fed now takes food and energy prices out of the inflation measure and instead reports what it calls “core inflation.” Thus we’re told inflation is only 2.7%.
The original rationale to exclude food was that the Fed should not try to offset weather‐induced supply shocks. Energy prices were also excluded because the Fed decided it should not try to offset OPEC‐induced supply shocks. The Fed wanted an inflation measure that excluded temporary changes and focused on persistent movements. But arbitrarily excluding major components is not the accepted way to remove volatility, and there is a lively debate among economists within the Fed on alternative techniques. Regardless of the outcome of that technical exercise, the core inflation measure has become a misleading statistic at best. The global food trade mitigates the effects of localized weather events. Rising energy prices are not the effects of one‐time supply shocks, but the systematic result of global demand.
Dollar users do not experience “core” inflation. What people purchase every day is precisely what is excluded from the core measure. For parents with growing children, milk, eggs and bread are not optional purchases. For millions of Americans, especially in the West, a long daily commute by car is a reality.
The Bush administration and its supporters have long pondered why it has not received credit for good economic policies. Perhaps this is in part because the benefit of tax cuts has been offset by rising energy prices, and now rising food prices.
The use of the core rate has lulled both the administration and the Fed into complacency, disconnecting them from the experience of ordinary consumers. Until recently, inflation doves pointed to the flat yield curve (long‐term interest rates close to short‐term ones) to buttress their case that inflation and inflationary expectations are low. But the bond market was slow to pick up on the new era of inflation in the 1970s. Not until 1974–75 did the long‐bond yield and the yield curve finally flash an inflation warning signal. From July 1974 to May 1975, the Fed funds/long bond yield spread went from negative 466 basis points to a positive 300 basis points.