Macroscope | In both the US and China, a focus on ‘core’ increases susceptibility to major policy blunders
- Just as a fixation on core inflation can mislead central banks, the power of a ‘core leader’ is a recipe for misdirected and ultimately unsustainable policy
- The very notion of a core adds a false sense of precision when policymakers attempt to address complex problems plaguing the country
It is tempting to give the US Federal Reserve credit for its about-face in tackling inflation. It is equally tempting to give President Xi Jinping credit for his stewardship of a rising China. Neither deserves it, and for a similar reason.
My emphasis is on the word “start”. The nominal FFR, now effectively at 3.1 per cent, remains 5 per cent below the three-month average of the headline inflation rate. Notwithstanding the Fed’s determination to arrest a serious outbreak of inflation, it is all but impossible to accomplish that with a real FFR of around -5 per cent.
This is where the debate gets tricky. Powell said on September 21 that Fed policy was in the lower end of the restrictive zone. He framed that judgment through the lens of underlying inflation measured by the “core personal consumption deflator”, which excludes food and energy. Annual core inflation on this basis was at 4.6 per cent through July.
This is disappointing for two reasons. The nominal FFR is well below Powell’s favoured inflation metric, and the Fed’s fixation on core inflation is dangerous. That latter point was true in the early 1970s, when I was part of the Fed’s staff that created the core, and it is true today.
