Free Slides from Ed Dolan’s
Econ Blog http://dolanecon.blogspot.com/ US Inflation: What is the “Trimmed Mean CPI,” and What Does It Tell Us? Post prepared September 18 , 2010 Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics , from BVT Publishers.

August 2010 Inflation Report: CPI
Rises 0.3% <ul><li>On September 17, 2010, news headlines reported that the US Consumer Price Index (CPI) for August had increased by 0.3 percent from the previous month (0.254 without rounding) </li></ul><ul><li>Is this a good or bad number? Unfortunately, a chart of monthly CPI changes does not help much in spotting inflation trends </li></ul><ul><li>What steps can we take to make the inflation data more useful for interpreting and formulating economic policy? </li></ul>Post P100918 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Step 1: Converting Inflation to
an Annual Rate <ul><li>Discussions of economic policy usually look at annual, not monthly rates of inflation. </li></ul><ul><li>If the August change of 0.254 percent was repeated every month for a full year, the annual rate of inflation would be 3.1 percent </li></ul><ul><li>This chart restates month-to-month inflation data at annual, instead of monthly rates. </li></ul>Post P100918 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Step 2: Month-to-month vs. year-to-year
changes <ul><li>Monthly inflation figures are highly variable. </li></ul><ul><li>Policy makers don’t want to overreact to very short term wiggles in the CPI; instead they want to focus on longer trends </li></ul><ul><li>One way to show the longer-term trend is to look at changes in the CPI from the same month a year before, rather than from the previous month </li></ul><ul><li>The blue line in this chart, which shows year-to-year changes in the CPI, gives a clearer picture of inflation trends </li></ul>Post P100918 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Step 3: Isolating “core inflation”
<ul><li>Some price increases lie largely beyond the influence of monetary and fiscal policy </li></ul><ul><li>Examples: </li></ul><ul><ul><li>Energy prices, which are set in global markets and are strongly influenced by world politics </li></ul></ul><ul><ul><li>Food prices, which depend on the weather and crop yields </li></ul></ul><ul><li>The Labor Department’s core CPI removes the influence of food and energy prices in an attempt to show trends that can be shaped by domestic economic policy </li></ul>Post P100918 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Step 4: Even Better? The
“Trimmed-Mean” CPI <ul><li>Food and energy are often, but not always, the most volatile prices—sometimes other sectors show unusual ups or downs that distort monthly data </li></ul><ul><li>The Cleveland Fed publishes a trimmed mean CPI that excludes those prices that move most each month, whatever the sector </li></ul><ul><li>The trimmed mean CPI shows the downward trend of inflation even more clearly than the core CPI </li></ul>Post P100918 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ The Cleveland Fed provides a nifty interactive tool that lets you put together your own inflation charts. You can find it here: http://www.clevelandfed.org/research/data/us-inflation/chartsdata/index.cfm

The Bottom Line: Keep your
Eye on the Trimmed Mean CPI <ul><li>Monthly inflation figures can sometimes signal a turning point in inflation, but those turning points are too often masked by random noise </li></ul><ul><li>The core CPI and trimmed mean CPI show that US inflation is still on downward trend—well below the Fed’s implicit policy target of about 2 percent per year </li></ul><ul><li>Expect the Fed to keep its monetary policy easy and interest rates low until the trend shows a clear upward turn </li></ul>Post P100918 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/