25 January 2010

Core Inflation v Interest Rates

The core consumer price index (an inflation measure that excludes food and energy prices in an effort to segregate buying power from international commodity market fluxuations) has stayed steady between 1% and 4% for the past twenty years, and is currently about 1.8% on an annual basis, right in the midpoint of the range.

But, interest rates appear to have tracked the overall consumer price index, which has varied much more and deviated a great deal more from core consumer prices than in prior time periods, including the energy crisis of the last 1970s and early 1980s where one would have expected core CPI to differ a great deal from overall CPI since an oil embargo was such a central piece of the stagflation experienced in that time period.

This could be because this is what the Fed, which is a key player in setting interest rates, cares about.

Adjusted against core inflation, interest rates right now are really low. Yet, the economic message that low interest rates are supposed to send (borrow more, save less), clearly do not appear to be trickling through to the economy which is doing precisely the opposite. Why?

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