The debate over inflation’s future path is for many a question of focus. For those who look to top-line inflation, as measured by the consumer price index or its cousin, the personal consumption expenditures index, the trend is clear: prices are rising.
But the response to the contrary comes by those who say that core measures of CPI and PCE are more relevant. By that standard, the trend of late reflects control and containment.
The disparity between the two measures of inflation is no great mystery. The rising price of energy is captured in top-line CPI and PCE, and this measure of inflation has been climbing. Energy and food are excluded from the core measures, which explain why core CPI and PCE look calm and their top-line counterparts are rising.
But as a recent research note from the St. Louis Fed reminds, the jury is still out on what a widening disparity between top-line and core measures of inflation means for monetary policy. “A disconnect between measures of headline and core inflation could be a concern for policymakers,” Riccardo DiCecio, an economist at the bank advised. “It may not be reasonable to conclude that monetary policy has been effective in maintaining price stability by looking solely at a core measure of inflation that excludes sustained oil price increases.”

DiCecio goes on to suggest that “an increase in energy prices could present monetary policymakers with a tradeoff between controlling inflation and stabilizing the output gap (i.e., the difference between actual and potential output) if these price increases affect actual output more than potential.” Clarity, however, is still missing. “The optimal resolution of this trade-off is an active area of research,” he notes, adding that readers can survey an outline of the debate in a recent research paper by Lutz Kilian (an economics professor at the University of Michigan) that’s slated for publication in The Journal of Economic Literature.
As Kilian pointed out in The Economic Effects of Energy Price Shocks, the challenge is one of understanding in greater detail how energy price shocks are relayed through the economy and how central bankers should react. Much of what was once thought known about energy-price shocks is now considered only partially true, if not completely misleading. A more granular analysis of what causes oil prices to rise, for instance, is critical for weighing the implications for the economy overall. Demand shocks and supply shocks, to cite two of the more commonly noted distinctions of late, shouldn’t be considered one and the same when it comes to energy bull markets.
That said, “The Economic Effects of Energy Price Shocks” states that “while no two oil price shocks are alike, most oil price shocks have been driven by a combination of strong global demand for industrial commodities (including crude oil) and expectations shifts,” or assumptions about the potential for future supply-related ills.
While no one should mindlessly assume that higher oil prices automatically lead to higher inflation per se, neither can one occupy the opposite philosophical extreme and relate energy as just one more commodity. At least not yet. The fact that inflation measures already recognize energy as something worthy of separate consideration suggests as much.
Nonetheless, ours is a moment of transition for deciding what higher energy prices mean for inflation. It’s tempting to conclude that the bull market in oil and gasoline (each driven by different factors) will have limited relevance for monetary policy, i.e., that there’s salvation embedded in core price trends. Perhaps, but it’s too early to make definitive judgments.
As DiCecio explained,
…price indices provide a snapshot of the dynamics of prices of a basket of goods and services. However, because each core index suppresses a different source of information, they each provide a different measure of inflation. Especially in times of substantial relative price movements, all price indices should be considered by policymakers and analysts.