For release: Jan. 4, 2002
Contact: Charles B. Henderson, (314) 444-8311

Food Prices: Something For Policymakers to Chew On

ST. LOUIS -- Putting food costs back into the price index might give policymakers a better handle on the underlying trends in inflation, argue two researchers at the Federal Reserve Bank of St. Louis.

The researchers are William T. Gavin and Rachel J. Mandal. Their analysis appears in the January issue of The Regional Economist, the St. Louis Fed's quarterly journal of business and economic subjects.

Economists looking at inflation generally track a price index, which is the average price of a consistent "basket" of consumer goods. The two major price indexes are the Consumer Price Index (CPI) and the Personal Consumption Expenditures Price Index (PCEPI). The CPI, which is reported by the Bureau of Labor Statistics, was created following World War I for the specific purpose of adjusting veterans' pension benefits for inflation. The PCEPI, which is reported by the Bureau of Economic Analysis, is used to compute the nation's Gross Domestic Product (GDP).

"Both indexes measure the rate of inflation consumers face, but the PCEPI is more comprehensive," said Gavin and Mandal. "Although both indexes are valid for gauging inflation, the Fed in 2000 began reporting its inflation forecasts in terms of the PCEPI instead of the CPI."

Gavin and Mandal noted that since the 1970s, core inflation has typically been measured by excluding food and energy prices from the basket of goods. This was done because the '70s had highly volatile food prices, followed soon afterward by a rapid rise in the prices of energy products such as gas oil. Since then, however, research indicates that although inflation in energy prices has been very volatile, food prices have become increasingly stable. Gavin and Mandal found several reasons for the latter:

1. Major advancements in the food distribution system have led to shorter lag times between produce being picked at the farm and getting into the hands of consumers.
2. Technological advances have reduced the cost of air freight and refrigeration, increasing the geographic size of the market for food and reducing the volatility of prices.
3. With their increasingly hectic schedules, Americans are purchasing more pre-prepared meals or eating at restaurants. The prices that they pay for these meals are largely expenditures on the labor used to prepare and serve the food -- prices that are less volatile than the price of the raw food products.

"Not only is the food component of PCEPI one of the least volatile components, but also it has been a relatively good predictor of inflation. Putting food back into the mix could improve inflation forecasts perhaps by as much as 10 percent," they concluded.

Subscriptions to The Regional Economist are free and can be obtained by calling (314) 444-8809. The publication is also available on the St. Louis Fed's web site: www.stls.frb.org.

With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. In addition to serving as a bank for depository institutions and the U.S. government, each Reserve Bank monitors economic conditions in the District, participates in formulating monetary policy, and supervises state-chartered member banks and bank holding companies to foster safety and soundness of the District's banking and financial institutions and to protect the credit rights of consumers.

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