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Irwin Kellner
Feb. 8, 2011, 12:01 a.m. EST
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U.S. economy looks ready for takeoff
First Take "º
CBS News: What will it look like now?
By Irwin Kellner, MarketWatch
PORT WASHINGTON, N.Y. (MarketWatch) "” It's time to look at all prices "” including food and energy.
One of the biggest canards ever to be foisted on the American people is the notion that removing food and energy from the price indexes provides a clearer picture of inflation.
In reality, it's just the opposite.
The so-called "core" rate of inflation (the headline price indexes minus food and energy) is grossly misleading. It was designed in the 1970s to take our eyes off what's really happening to prices so the Federal Reserve could maintain an ultra-easy monetary policy.
Guess what? This is exactly what the Fed is using it for today.
Taking food and energy out of the price indexes was the brainstorm of the then-Fed chairman, Arthur Burns. He was looking for a rationale to keep policy easy in order to help Richard Nixon's bid to be re-elected president, back in 1972.
Burns reasoned that no amount of money created by the Fed could produce one bushel of wheat or one barrel of oil. Their prices related mainly to such exogenous factors as the weather and geopolitics. As such, they have nothing to do with the state of the economy.
The professorial Burns managed to convince the Congress, the Bureau of Labor Statistics, which issues these indexes, the press and his fellow economists that this was the right way to look at prices. Not surprisingly, "core" inflation took hold and is widely used to this day.
Today's Fed is focusing on core inflation (which is low) so it can place more emphasis on trying to reduce unemployment as opposed to holding inflation down. As you can imagine, this gambit also appeals to politicians.
There are several reasons why excluding food and energy from any discussion of inflation is misleading.
First, since we all consume food and use energy on a daily basis, what happens to prices of these commodities can and does influence other prices. They do this by affecting attitudes toward inflation "” precisely because they are an everyday staple.
To put it another way, what happens to prices of homes, autos and even clothing is not as important as what happens to food and energy in terms of affecting the expectation of inflation, simply because most people are exposed to these price changes only infrequently.
As I observed in my column of Sept. 28, 2010, prices of many commodities are already rising rapidly.
Not surprisingly, companies are passing these higher costs along by raising their own selling prices. Some are even beginning to stockpile many goods before their prices go up.
The bond markets are reacting to this pickup in the rate of inflation. The yield on long Treasurys is now at its highest level in almost a year. Another measure of market thinking, the Treasury-TIPS spread is also back to levels reached last April.
The final reason comes from one of Arthur Burns' star pupils, Milton Friedman, who said time and again that inflation is first and foremost a monetary phenomenon "” which today's Fed is creating at record rates.
It's only a matter of time before food and energy prices get swept up with the rest. That's when core will be no more.
Irwin Kellner is MarketWatch's chief economist.
Irwin Kellner, MarketWatch's chief economist since 1998, writes a weekly column on the economy and the financial markets. He has been a leading economist for more than 40 years and previously served as chief economist for North Fork Bank, Chase, Chemical and Manufacturers Hanover. Widely quoted by the media in the U.S. and abroad, Kellner regularly addresses groups of business people and community leaders and appears regularly on Cablevision's News 12 Long Island.
A shakeup could be just what CBS News needs, writes Jon Friedman.
12:51 p.m. Today12:51 p.m. Feb. 8, 2011
"Irwin Kellner: Inflation numbers are rotten to the core http://bit.ly/dKFI1R" 12:44 a.m. EST, Feb. 8, 2011 from MktwKellner
"Irwin Kellner: U.S. economy looks ready for takeoff http://bit.ly/hCkgAH" 2:01 a.m. EST, Feb. 1, 2011 from MktwKellner
"Irwin Kellner: Super Bowl theory suggests stocks will rise http://bit.ly/h2S7Lt" 1:50 a.m. EST, Jan. 25, 2011 from MktwKellner
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