Something I've never quite understood about inflation is why prices for food and oil are excluded from the calculation of so-called "core inflation." It seems to me that a basic necessity of life and a commodity that allows people to labor for and pursue the former are both about as "core" as one can get. Can someone explain the reasons for this convention to me? And am I wrong in thinking that the numbers normally cited in soothing tones ("inflation's only 5%, dear; and look, there's not a bunch of child molesters lurking around the playground, just that one") are generally measurements of core inflation?

The rationale for considering core inflation comes about because food and energy prices are more volatile than prices for other consumer items. A drought, flood, or freeze could cause food prices to rise temporarily; political events can cause oil prices to rise or fall temporarily. Of course, the commissars could just count the last six months' or year's moving average of food and energy prices. But they prefer to omit food and energy lately because it makes inflation seem higher.

Sawbones,

Food and fuel were seperated out from 'core' inflation, because they have had great price fluctuations... in the past. Fruits and vegetables used to be quite seasonal as was spending on fuel (lots of demand for heating oil in the winter, not so much in summer). And, in order to not have inflation soaring one month and crashing the next, they removed those two categories to 'smooth' things out. These kinds of statistical adjustments are also made for retail sales figures and employment (i.e. Christmas shopping and kids finding jobs during the summer).

The logic has broken down now in inflation calculations since food and fuel costs are now trending up quite steeply. So, you're right in thinking that the core inflation figures understate what's going on.

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Approaching this from an accounting perspective, it's to make things look better. For this reason, we have such measures as EBITDA, or "earnings before interest, taxes, depreciation and amortization." This is the measure you highlight when trying to sell your company. Also, you want to exclude write-offs and one-time charges ("that's the past; let's talk about the future"). One accounting wag (such as there are) suggested the measure EEBS, or "earnings before bad stuff." Of course, these measures are labeled as such, and any buyer with a BS detector is going to be skeptical.

Such is not the case with voters. Politics is not necessarily zero sum, and incumbents like to blame things on Fed stinginess while engaging in a pork fest. Therefore, they downplay inflation.

Either that, or economists never go anywhere or eat anything.

I believe the replies above were well meaning, but.......here's the cold reality.

<link>

A really good read and I think will answer most of your questions.

z

All that reminds me a lot of Prof Abraham Briloff who wrote a book called Unaccountable Accounting circa 1973.

His analogue to GAAP (Generally Accepted Accounting Principles) was CRAP (Cleverly Rigged Accounting Ploys).

Concepts like EBIT or EBITDA, or Core Inflation are all valid and useful tools, but unfortunately, many times are misused specifically because those citing prefer the results, rather than because they are the most relevant measure for the intended purpose.

sawbones:

I think Daniel sums it up nicely here:

"What's more, the Fed tends to focus on things that it can control, and not even a Fed chairman as powerful as Alan Greenspan can affect the price of oil by manipulating interest rates."

<link> "Food, Prices, and Central" Bankers Daniel Gross 2005

Lets tackle oil first. I think I have said this athousand times over the last 5 years, the Arabs do not care what the Fed does as far as interest rates. If they do not like the dollar, they will just switch to the Euro as Iraq did pre-911 and as Iran was ready to do also. Print more money or cheap the dollar and the price of oil goes up regardless.

Food is a volatile commodity. A freeze in Florida can impact, floods in Iowa can hurt, hurricanes in the gulf can affect, etc. Furthermore what many people do not realize is an ~50% of our food comes from outside of the US. The same as oil, the impact of the Fed on the dollar will increase prices or decrease prices. If you want a vision of what it will be like in the future for food, look at the history of oil as more of our food is bought out side of the US and imported.

In 1973, Fed Chairman Arthur Burns asked that oil, and eventually food (for other reasons than imports), be excluded from the CPI to not influence Fed policy. If the Fed did include both commodities in the CPI calculation fo policy decisions, should we be increasing interest rates to control the impact of oil and food upon it? One other president did just such in the late twenties and the result of that action helped lead to the worst recession ever experienced in this country . . . The Depression.

The CPI as you may have known it in the past 10 years has also taken another twist with how it is calculated. The basket of commodities it is measured against keeps changing as consumer preferences change for example pork to beef and vice versa, latest and greatest computers or new products, quality improvements, and discounting. The BLS developed a "chained consumer price index" to pick up these subtle changes and account for price changes also. It further tamps down the impact of inflation or price changes in many scenarios. This change was kicked off in 2002 and picked up by Greenspin in 2003. <link> Chain Weighted CPI

A side point that may be of infterest. Comparative advantage works if everyone is friendly with the other. I do not see a lot of friendship towards the US in the world today as shown by oil and its availability to us. We really need to take a look at certain things as strategic commodities to the US, which has gone away in favor of "laissez faire" and Gregor's "invisible hand" (not wing-chun either). Look at them and develop long range national plans as to how we will live under the impact of dwindling commodity, greater imports, whether it is desireable, and whether we can impact the long range. This has also been my stance for a long time as opposed to letting the "market decide" through divine and invisible direction. When I travel on a journey, I am prone to having a map with the idea we can make small changes along the way and know where we are ultimately going.

Each poster has added a bit to the discussion of CPI. And yes ultimately, energy increases carries through to everything in which case you have already experienced the impact of energy. Yes? There are three indexes and the one you seek includes energy although the Fed uses the Chained Index. The links should explain some more on the topic.

Then again, most individual investors don't actually read the financial statements. They rely on analysts to do that (which is a whole different topic).

People responsible for buying out companies know the score. The tax structure and debt structure will change after a buy-out, and depreciation doesn't affect cash flow. So those are useful measures. In context.

Excluding Bad Stuff (extraordinary charges, write-offs) is the closest analogy to "core inflation". Forget those bad things of the past. They would interfere with the smooth upward curve we wish to present.

i'm not an economist, and i somewhat disagree with the exclusion which you too object to. that said, i'll paraphrase the explanations i've read previously:

"food and energy have "seasonal" variations. gasoline is higher in summer, heating oil is higher in winter, food is cheaper in summer when fresh fruits don't have to come from australia or south america, etc. the objective is to "flatten" seasonal variations so that programs which rely on CPI - such as social security, do not end up under or over doing the benefits formula."

develop long range national plans

uh - ya mean like "5-year plans"?

Sorry - theyr'e a no go.

We know they don't work.

They just got hydroelectric plants built and enough armaments to at least hold the Germans off till winter did the rest.

"long-range national plans"!!!!

Ha!

If it's any consolation, increases in energy costs will work their way through the system and eventually show up as increases in other things that are counted in core inflation, so maybe they're just trying to avoid counting energy twice.

Not only are food and energy excluded, so is housing. What percent do those 3 components account for in the average household budget, perhaps 60%.

And why does the government need to "tamp down" inflation? Because a number of items use this number for future calculations. For instance, annual Social Security increases use this number. This is one of the way SS has been kept fiscally sound, i.e., by reducing benefits using phoney inflation numbers.

To me the real laugher is when they include exports in Gross Domestic Product. Anything to keep from admitting that real GDP is negative.

You are right on one point. The government wants to tamp down reported inflation to keep from paying out higher Social Security benefits.

Dallas:

1. Without the Chained CPI, Social Security IS Fiscally Sound and will be so throught 2042 and perhaps beyond with no change in benefits.
2. I thought I explained why they are doing this rather well . . . read it again.
3. The old indexes are still there to explain inflation the old way.