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Food for the Fed
Subject Inflation
Topic Employment, Unemployment, and Inflation
Key Words Inflation, Consumer Price Index, Interest Rates, Federal Reserve
News Story

The Labor Department reported that consumer prices increased 0.2 percent in July. Many analysts believe that this modest increase will cause the Federal Reserve to maintain interest rates at their current level. On an annual basis, the July Consumer Price Index (CPI) reported a reduction in the annual inflation rate to from June's 3.7 percent to 3.7 percent annual increase. Since this is the last important price data before the Federal Reserve's August meeting, many economists believe the modest increase in the CPI coupled with a Commerce Department report that housing starts had declined 3.3 percent in July, the slowest pace since late 1997 would convince the Fed to leave interest rates unchanged. Others argue that inflationary pressures have increased and additional rate hikes will be needed.

The July increase in the CPI of 0.2 percent was considerably lower than the 0.6 percent increase reported for June. The core inflation rate, that is the CPI minus the volatile food and energy sectors, also increased 0.2 percent - the fourth consecutive month of an increase of this magnitude. The core inflation rate is 2.6 percent on an annual basis, up slightly from the 1.9 percent increase in 1999. Apparel and transportation were the only sectors where prices had fallen. Medical care costs continued to rise: up over 4 percent for the year.

The opposite view is that there is an upward drift to inflation. Economists holding this opinion note inflation increased at a 4 percent rate in 2000 compared with a 2.7 percent increase in1999. Adding to their view of increasing pressure on prices, a report on retail sales released last week showed that retail sales continue to be strong. Furthermore, the weakness reported in the home-building report was from a single region, the South, and may have resulted from poor weather conditions rather than decreased demand.

(Updated September 1, 2000)

Questions

1. What is inflation? In your answer distinguish between a change in relative prices and a change in the absolute level of prices.
2. How is the CPI calculated? Explain how the CPI is used to measure inflation.
3. Why is inflation a concern to the Federal Reserve? Why would a high inflation rate casue them to increase interest rates?

Source Robert D. Hershey, Jr., "Pace of Consumer Inflation Registers Only a Slight Gain," The New York Times, August 17, 2000.

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