This document is a weekly commentary by Dr. Scott Brown discussing inflation and the Federal Reserve. It notes that while deflation seemed a threat a year ago, energy price increases have boosted consumer prices over the last 12 months. However, core inflation remains low thanks to weak housing rents. The Federal Reserve has signaled keeping interest rates low for an extended period given high unemployment, low core inflation, and stable expectations. Measures of core inflation like the core PCE index remain at low levels, suggesting no need for the Fed to raise rates soon despite some calls for higher rates. Higher energy prices pose a risk but are more a drag on growth than a driver of higher underlying inflation.

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Weekly Commentary by Dr. Scott Brown
Inflation And The Fed
March 15 – March 19, 2010
A year ago, in a sharply weakening economy, deflation seemed a credible threat. However, a rebound in energy prices has boosted the Consumer Price Index
over the last 12 months. Improvement in the global economy has led to a firming in commodity prices. Despite the diminished threat of deflation, core inflation
at the consumer level has trended lower, thanks in large part to weakness in rents (a consequence of residential housing troubles). Policymakers at the Federal
Reserve have signaled that economic conditions are likely to warrant exceptionally low interest rates “for an extended period.” Those conditions include an
elevated unemployment rate, a low trend in core inflation, and well-anchored inflation expectations. None of that seems likely to change anytime soon.
The Consumer Price Index ex-food & energy is the most common measure of core inflation. Food & energy do matter, of course – and the headline CPI is used
to adjust things like Social Security payments – but we are most interested in the underlying trend in inflation. Food and energy prices, being volatile, tend to add

2. a lot of noise. The Fed’s focus has traditionally been on the price deflator for personal consumption expenditures. While the Consumer Price Index is based on a
fixed basket of goods and services, the PCE Price Index allows the weightings to change as patterns of consumption change. The core PCE Price Index rose 1.4%
in the 12 months ending in January. There are other measures of core inflation. These include median measures (reflecting the middle of price changes) and
trimmed-mean measures (which exclude some portion of the highest and lowest price increases each month). All of these measures have been trending at low
levels.
The Federal Reserve has two goals. Price stability and maximum sustainable employment. By “price stability”, we mean low inflation – not zero inflation. Over
time, there have been many legislative efforts to change the Fed’s mandate to a signal goal: low inflation. However, there is solid empirical evidence that by
keeping inflation low over the long term, job growth will be stronger than it would be otherwise. Yet, while the Fed is firmly committed to keeping inflation low,
it is also sensitive to labor market weakness.

3. With an elevated unemployment rate, a low trend in core inflation, and steady inflation expectations, there should be no pressing need for the Fed to raise the
federal funds rate target. Some of the Fed’s district bank presidents have made hawkish comments, suggesting that rates may need to be hiked sooner rather than
later. However, Bernanke is an expert on the Great Depression and realizes the danger of tightening credit too soon (moreover, with consumer and business credit
declining, why should the Fed want to tighten credit?).

4. Energy prices are a wildcard in the economic outlook. However, recent history suggests that higher oil prices are more of an impediment to economic growth
than a catalyst for a higher trend in underlying inflation.