Yellen to study broad range of indicators in search of inflation

Federal Reserve Chair Janet Yellen enjoys a meal. When menu prices increase, it's a sign restaurant owners see inflation bubbling. Photo / AP
Federal Reserve Chair Janet Yellen enjoys a meal. When menu prices increase, it's a sign restaurant owners see inflation bubbling. Photo / AP

The next time Federal Reserve Chair Janet Yellen grabs dinner at her favourite eatery, she might want to take a longer look at the cost of her entrée.

That's because menu prices don't change as often as those for many other goods and services. When they do increase, the move has to count, and it's a sign restaurant owners see inflation bubbling, according to Michael Bryan, a senior economist at the Federal Reserve Bank of Atlanta.

The "sticky" consumer-price index, which only includes items with slowly changing costs such as food consumed away from home and car repairs, is one of the alternative measures that policymakers monitor. Other calculations by the Cleveland and Dallas Fed banks also strip out more volatile components, aiming to quiet the "noise" Yellen has suggested can affect broader measures, including the central bank's favourite.

The message from these less conventional gauges: Inflation has bottomed out and is increasing, though not enough to cause concern at the central bank.

"There's nothing that would make you think that they're going to overshoot their target" for inflation, said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey.

Muted underlying price pressures mean the central bank can keep short-term interest rates pinned near zero well into 2015. The Fed won't raise rates until the third quarter of next year, according to the median forecast of economists in a Bloomberg survey earlier this month.

Fed's target

The Fed's target for inflation is 2 per cent. Their preferred gauge, the personal consumption expenditure price index, was up 1.8 per cent in May from a year earlier. Its 12-month gain was as low as 0.8 per cent in February.

Yellen and her colleagues start a two-day meeting to plot policy on Tuesday, with Fed watchers predicting the central bank will decide to reduce its monthly bond purchases by another $10 billion.

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At their last meeting on June 17-18, policymakers looked at "a range of price measures, including the PCE price index, the CPI and a number of the analytical measures developed at the Reserve Banks," according to the minutes of that gathering. They found inflation is rising in line with their forecasts of a gradual increase over the next few years.

Just as Yellen looks at an employment "dashboard" of various government statistics to assess the health of the jobs market, policy makers are studying various measures of inflation to try to determine the trend in prices because the traditional measures can cloud the underlying trajectory, Crandall said.

Alternative measures

"Alternative price indexes as well as wage data will play a role in shaping the Fed's own inflation expectations, and thus its policy stance," he said.

The regional Fed measures indicate inflation already may be leveling off following its recent pickup. The Atlanta Fed's measure of sticky prices, which includes goods and services whose costs typically change less frequently than every 4.3 months, rose 2.1 per cent in the year ended June, the same as in May. Prices in this leaner basket rose in June from the prior month at an annualised pace of 2.3 per cent, down from a 2.9 per cent increase in May and 3 per cent in April.

"We think sticky prices give you a much better idea" of where inflation may be headed, the Atlanta Fed's Bryan said. "If I'm only going to change my price once a year, I'm going to be thinking about what's going to happen over the next 12 months."

Research by the Cleveland Fed has found that a simple measure of the median price change of all items tallied by the Bureau of Labor Statistics allows for a better reading on underlying inflation than either the CPI's group of all items or its core measure, which excludes food and energy prices.

Food, fuel

"Everybody eats, everybody goes to the gas station," said Edward Knotek, a vice president at the Cleveland Fed who leads the development of the bank's forecasting models. "Those are very visible prices. It's not clear you should always strip them out."

Cleveland's median CPI rose 2.3 per cent in June year-over-year, matching the biggest increase since May 2009. At the same time, the gauge showed prices advancing 0.2 per cent from May after two straight 0.3 per cent monthly readings.

The Dallas Fed eliminates 31 per cent of the goods and services that show the biggest increase in prices in any one month and 24 per cent of those at the other end of the spectrum. The gainers taken out in May included coffee, casino gambling and perfume. Dishes, movie tickets and sporting goods were among the biggest decliners and also were slashed.

The so-called trimmed-mean gauge saw prices increase 1.7 per cent year-over-year in May, just short of the 1.8 per cent in the PCE headline.

'Big three'

Considering what Dallas Fed senior economist Jim Dolmas calls the "big three" components with the greatest impact on inflation - two tracking rents and one measuring the cost of dining out - prices aren't swelling. The cost of those items combined rose 2.6 per cent year-over-year in May, the same as in the prior month.

The alternative measures remove the more fickle price categories, such as food, gasoline and airfares.

"Gasoline and energy prices in general have an awful lot of volatility that tells you very little about any sort of persistent inflation trends," said Michael Hanson, a senior US economist for Bank of America in New York and a former Fed economist. "The data right now I would say don't give a strong reason to think the Fed is materially behind the curve" in their read on inflation.

Airfares' influence

Relatively small items such as plane tickets also have played an outsized role in boosting price indexes recently, said Laura Rosner, an economist at BNP Paribas in New York.

Airfares, which make up about 0.5 per cent of the core PCE index, accounted for 11 per cent of the change in that measure in the three months ended May, according to Rosner's calculations. The Bureau of Labor Statistics has been trying to enhance the way it tracks these costs by mining the Internet, which means it may take a while to smooth out the data for seasonal volatility, she said.

"There's still a lot of things that are weighing down on prices," said Rosner, a former New York Fed researcher. Labour market slack and sluggish wage growth remain headwinds for price gains, she said.

- Bloomberg

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