Remedial Economics (aka Economics For Dummies)

Okay, I have been asked by more than one person (actually more than two) for further explanation of my CPI/Inflation email.  So here goes:

This month’s indication of price inflation as measured by the Consumer Price Index increased to an annual rate of 2.7%, taking all factors into consideration.  That is up from last month’s rate of 2.1% annual rate. Using simple math that’s a 28% increase.  So, inflation is picking up.  A little inflation is not so bad.  A lot of inflation is not so good.

However, the Federal Reserve Board of Governors (aka “The Fed”) does not use that rate when they meet to determine economic policy, they use what is called the “Core” CPI number, which takes out some of the more volatile things that can be influenced by seasonality or weather, like food and energy prices.  That number was 1.2% this month as compared to 1.1% last month.  Once again using simple math, that’s a 9% increase.

However, most consumers shop for groceries and fill up with gas very regularly, so most consumers feel the inflation of food and energy prices from week to week and month to month.

The Fed uses these CPI inflation numbers (along with a lot of other things) to help them do things like set interest rate targets.  Their interest rate targets are important because it influences things like bank deposit rates, bank lending rates, the relative attractiveness of stocks and bonds, and even the exchange rates for currencies like the Dollar, the Euro, the Yen, etc.  Now, The Fed doesn’t control all these prices, but its economic polices definitely influences them.

Generally speaking from a historic perspective, short term interest rates usually have hovered somewhere around the inflation rate.  Today the 3 month Treasury bill rate is yielding .07% (7 tenths of 1 percent).  That’s a far cry from either the Core CPI inflation rate of 1.2% or the more broad CPI inflation rate of 2.7%.  And so The Fed through its economic policies and market actions is helping to hold down the interest rate on Treasury bills, notes and bonds which in turn is making other assets (stocks, commodities, etc.) more attractive and helping drive their values up.  However, at some point The Fed is going to have to stop their market intervention  and at that point the all these markets will have to adjust to a new interest rate environment.

So the question is at what point should The Fed begin to let interest rates seek their normal market rates.  I think that time is upon us.  A majority of The Fed members apparently do not think like I do.  And I must point out they have a lot more PhD’s  than I do.  Well, actually, I don’t have a PhD so that’s a pretty low hurdle.  Still, if you’ve gone to the store to buy meat any time lately you have probably noticed that the price per pound has gone up.  And if you haven’t noticed that the price of gas at the pump has gone up then you probably do not drive a car (which apparently Ben Bernanke does not).

So, purely technically speaking, I think The Fed has do-do between their ears.