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Paul Krugman

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Even though commodities were down sharply on Tuesday, their high prices continue to stir much debate over their impact on inflation. Paul Krugman, writing in his New York Times blog, continues to stress the importance of looking at "core" inflation, which strips out volatile food and energy items (read: commodities).

Indeed, Mr. Krugman appears almost overjoyed to see that the Federal Reserve Bank of Chicago agrees with this position. In a blog item of Tuesday, he linked to a Chicago Fed paper, "What are the implications of rising commodity prices for inflation and monetary policy?" - whose answer is:

"Clearly, higher prices of food and energy end up in the broadest measures of consumer price inflation, such as the Consumer Price Index. Since the mid-1980s, however, sharp increases and decreases in commodity prices have had little, if any, impact on core inflation, the measure that excludes food and energy prices."

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Mr. Krugman helpfully includes a graph on his blog, plotting the dramatic ups and downs of commodity prices against core inflation since 1993. While commodity prices swing all over the place, core inflation remains relatively stable, implying that monetary policy would be tremendously flighty if it followed, say, crude oil prices.

Meanwhile, The New Yorker's James Surowiecki (via Free Exchange) weighs in with some interesting thoughts about rising energy costs, noting the relatively small impact they have on consumers' wallets next to the fear they can instill. Why?

"Few things loom as large in the public imagination as gas prices, which have an unusual, and much studied, ability to make people feel poorer," he explains. "Gas prices are ... literally the most visible prices we have; you can't take a drive without seeing huge signs reminding you how much gas costs. Dan Ariely, a behavioral economist at Duke, has even argued that the way we buy gasoline - standing at the pump and watching the dollars pile up - is inherently disheartening."

Mr. Surowiecki concludes that the real danger surrounding energy prices right now is more psychological than economic. That is, concern about rising prices feeds uncertainty, which leads to reduced consumer spending. No wonder than consumer spending plummeted last month, even though readings on employment continue to suggest modest improvements.

"The danger of self-fulfilling pessimism is important at a government level, too," he said. "If the Federal Reserve overreacts to higher oil prices and goes into full inflation-fighting mode - raising interest rates, as the European Central Bank did, foolishly, last week - it would risk slamming on the brakes just as the economy is finally getting into gear."

If there is a great takeaway from his article, it is one word: Calling the ECB's rate hike "foolish."

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