May 24, 2007 / 9:33 PM / 13 years ago

Core inflation testing Fed credibility -Dallas Fed

DALLAS, May 24 (Reuters) - The Federal Reserve’s adherence to core inflation, which strips out food and energy prices, is taxing the public’s patience and risks credibility, a senior U.S. central banker said on Thursday.

“In the United States over the last 20 years, core measures excluding food and energy did take out a lot of noise. But in the last three years it has been extracting quite a bit of signal,” said Harvey Rosenblum, head of research at the Federal Reserve Bank of Dallas.

Central bankers study core inflation because it is supposed to remove volatile one-off price movements to reveal an underlying “signal” of price pressures. But this practice is challenged when the components being removed keep rising.

Speaking to reporters on the sidelines of a conference co-hosted by the Dallas and Cleveland Federal Reserve banks on measuring inflation and inflation expectations, Rosenblum said that this issue has not gone unnoticed.

“In the last three years, energy has moved in one direction for the most part, and food over the last two years has moved primarily up. And it is becoming annoying to people to see the central bank exclude those,” he said.

The U.S. core consumer price index rose 0.2 percent in April and stood 2.3 percent higher compared with 12 months before. Headline CPI fell 0.4 percent in the month and was up 2.6 percent year-on-year.

As well as source of irritation, there were risks to being seen as out of touch with the real world for policy-makers trying to influence economic behavior through their communication strategy and interest rate decisions.

“You have to have the faith and trust of the citizens that you serve. You have to be able to communicate to them in a way that looks like you are aware of what they are experiencing in their daily lives,” Rosenblum said.

“It is absolutely critical that when you are communicating with them, you sound like you are knowledgeable about what they experience, and that you have got your measurements at least on the same approximation (to) what they are feeling,” he said.

On the other hand, Rosenblum said that because the Fed relies on a number of different measures of price pressure, there was not much risk the flaws in core inflation would translate into a policy mistake.

“The fact that core is misbehaving now because food and energy are moving in one direction instead of up and down is not all that troublesome to me because we have the good sense to look at the wide range of indicators out there,” he said.

“The point is the Federal Reserve is very forward looking and it is more the accuracy of our forecast that is going to determine whether we are going to be making policy errors or not,” he said.

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