Sunday, November 18, 2012

Core CPI Curve

when the Company Store introduced the lastest queasy money scheme a couple months ago, I recall a number of pundits arguing that the dual mandate was unworkable and the Fed's defense of employment should be dropped. controlling inflation, they say, should be the sole mandate.


well, I submit they would have taken the same action even if inflation were their only business. earlier in the year, I devised an easy way to visualize trends in the Core CPI (though it'll work with most indexes or indicators). it is essentially a yield curve graph (like you see for interest rates) applied to the index. here's one that incorporates the latest (October) CPI values:


each bar represents the annualized rate of change for the index over different periods. so from September to October the Core CPI rose at a rate of nearly 2.2 percent (annualized). then the curve goes back proportionally to about seven years (86 months). I used these 15 points (which you may notice are Padovan numbers) deliberately, because not only is the median interval 12 months (the popular year-on-year rate), but the geometric average of all the intervals is also very close to 12 months. 

so the curve above shows the inflation rate being pressured higher over the past couple months, back into the two percent range, which is what the Company Store's always jawboning about. now let's see what the curve looked like in the month prior:


this graph shows a notable uptick from August to September, but still below the two percent target. 

lastly, let's look at the curve as it looked from the August report, which was the last month of CPI data available when the Fed introduced its latest QE initiative:


now look at that chart, it is this trend of lower inflation readings that Fed had been fretting over when it unveiled the new policy accommodation at the September meeting. furthermore, there had been only two intervals (21 and 16 months) across the entire curve with an annualized rate above two percent, and those just barely. 

we will continue to monitor these inflation curves as the CPI updates each month. but from the standpoint of Fed's own internal logic, it will be naive to expect any reversal of policy (tightening) until we see a curve graph with an ascending trajectory from left to right and an average interval value well above two percent. conversely, the Fed is unlikely to unveil new or expanded accommodation until the curve renews a downward slope like we saw a few months back.