South-Western College Publishing - Economics  
Gas and Food Prices Increase, Core Inflation Rate Falls
Topic Employment, Unemployment, and Inflation
Key Words Inflation, Gas and Food Prices
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Reference ID: A165085316

News Story The decrease in the core rate of inflation brought cheers of joy from Wall Street types who were in the midst of a stock rally that was continued by the announced change in the core rate. Overall, the Consumer Price Index rose 0.7 percent in May, the Labor Department reported. The Fed, however, keeps an eye on the other measure of inflationary pressure in the economy. The so called core rate of inflation excludes food and energy in the calculations and leads the Fed’s thinking on interest rates.

The core rate was up only 0.1 percent in May, a rate that will encourage the Fed to leave interest rates alone and investors happy. Consumers, on the other hand, see little reassurance for their own wellbeing since their budgets are being stretch to the max by higher food and gas prices.

A measure of consumer confidence in the economy is published by the University of Michigan. The latest report found that consumer confidence in the economy dropped to its lowest level in 10 months. According to the university’s survey, Americans are expecting significantly higher inflation in the near future than they expected a few months ago.

“Everybody has to eat, and everybody has to drive to work,” said Mark Vitner, senior economist for Wachovia. “For households, the headline number truly is the more important number, and clearly the run-up in gasoline prices in the last few months has left consumers with less money to spend on everything else.”

Officially the Fed is holding firm in its posture that inflation is still the biggest threat to the economy. Some analysts feel that the continuing downward trend in the core rate will finally allow the Fed to change its language to recognize inflation is not so serious but others disagree. “It’s too early to say that inflation isn’t an issue,” said James Knightley, senior economist with ING Wholesale Banking. He pointed out that the 0.1 percent core inflation figure for Many was rounded down form 0.149 – a negligible difference from April’s 0.177 percent.

As far as the Fed is concerned, as long as energy prices remain volatile, it is probably to their benefit to keep talking tough on inflation and leave the lingering threat of increasing interest rates in their official position. If energy prices continue to rise and then be passed on through the prices of other products, inflation could exceed the Feds acceptable level of 1 to 2 percent. If this occurred, the Fed may increase interest rates to slow the inflationary pressure.

Discussion Questions:
1. Discuss the notion of energy prices seeping into the prices of other products.
2. Discuss why the Fed prefers the core rate of inflation as opposed to the overall rate.
Multiple Choice/True False Questions:
1. The measure of core inflation excludes:
  1. housing and energy prices.
  2. energy and durable goods prices.
  3. housing and food prices.
  4. food and energy prices.
2. The Fed defines an acceptable rate of core inflation as between:
  1. 1 and 2 percent.
  2. 2 and 3 percent.
  3. 3 and 4 percent.
  4. 4 and 5 percent.
Source Jeremy Peters, “Cost of Gas and Food Rose Sharply Last Month”, The New York Times Online, June 16, 2007.
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