Friday, September 19, 2008

Frederic Mishkin Defends Core Inflation

Frederic Mishkin, a former Federal Reserve Board member, wrote a WSJ opinion piece defending the core inflation measure. I've called core inflation a useless, misleading number:

I was eager to see how Mr. Mishkin would defend a statistic seemingly designed to insulate the government from macroeconomic criticism. Mr. Mishkin's article is below:

To his credit, Mr. Mishkin intelligently argues that the Fed must maintain a "nominal anchor," and food and gas prices (what he refers to as "headline inflation") fluctuate too much to maintain a steady beacon.

As any statistician knows, however, there are ways to mitigate the extremes in any number sample. The Dallas Fed Reserve does just that by publishing "trimmed mean" figures, which are basically inflation numbers sans the extremes on either the high or low side. Mr. Mishkin provides a good defense of core inflation in principle, but I am still not convinced. A "nominal anchor" isn't going to provide any predictability if everyone knows the real numbers are much different than reality. Numbers need to have credibility first. That starts by acknowledging inflation numbers should include items most Americans use daily, such as food and gas prices.

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