Oct. 20 (Bloomberg) -- Federal Reserve Governor Frederic Mishkin said inflation measures that exclude food and energy costs are a ``better guide'' to underlying changes in prices.

Changes in price indexes without food and energy ``provide a clearer picture of underlying inflation pressures,'' Mishkin said in the text of remarks to the HEC Montreal Macroeconomics and Monetary Policy Conference today. ``If the monetary authorities react to headline inflation numbers, they run the risk of responding to merely temporary fluctuations.''

Mishkin argued that both so-called core and headline measures of inflation are useful to policy makers and the central bank shouldn't rely on any one gauge. Sustained increases in energy costs can push up expectations for inflation, he said, noting that recent gains in oil are a ``reminder that shocks can persist longer than one might have first expected.''

The Fed governor didn't comment on the outlook for interest rates or the economy in the text of his remarks.

Mishkin, as all governors, is a voting member of the Federal Open Market Committee, which cut the benchmark rate by a half point on Sept. 18. Fed officials next meet Oct. 30-31. Federal funds futures show investors indicate a 59 percent chance that the rate will be cut by a quarter point to 4.5 percent.

It makes ``sense for central banks to emphasize headline inflation when determining the appropriate stance of monetary policy over the medium run,'' Mishkin said. ``But policy makers also are right to emphasize core inflation when deciding how to adjust policy from meeting to meeting.''

Best Sign

Gauges of total inflation are most important to consumers because it includes everyday items such as gasoline and groceries, the Fed governor said. At the same time, an increase in core inflation measures may be the best sign that higher headline inflation is starting to stick.

``A measure of core inflation that is easily understood and provides some greater signal about persistent movements in inflation than does headline inflation is extremely valuable,'' Mishkin said.

The consumer price index, minus food and energy, rose 2.1 percent for the 12 months that ended in September, a tenth of a percent below its average for the past six months. Adding food and fuel, the index rose 2.8 percent for the period, up from 2 percent for the year ending August, an indication of the kind of volatility headline measures experience.

Mishkin noted that the increase in energy prices of recent years hasn't crept into core measures, in part because the public has confidence the central bank will keep inflation low.

Fed's Mandate

An aggressive response to headline inflation wouldn't conform to the Fed's dual mandate of achieving both stable prices and full employment, because of the cost of job losses, Mishkin said. He cited simulations of policy actions and their economic effects run on the Fed's main computer model.

``Responding to headline inflation is therefore inappropriate because it generates extensive variability in the unemployment rate,'' Mishkin said.

The Fed's preferred price gauge is the core personal consumption expenditures price index, which is tied to consumer spending patterns. The CPI is measured on a fixed basket of goods and services. The PCE index, minus food and energy, rose 1.8 percent in the 12 months to August.

Public expectations of inflation in one year have fallen in the past four months, to 3 percent in October from 3.4 percent in July, according to a survey by the University of Michigan.

Miskhin is an advocate of inflation targeting, a strategy where a central bank names its numeric price goal and tries to hit it over time.

Having a numerical goal for price increases, with a ``tolerance range'' around it, is as an ``excellent'' way to conduct monetary policy, Mishkin wrote in ``Monetary Policy Strategy,'' a book scheduled for release in November by the MIT Press. The book was completed before Mishkin's Fed appointment in September 2006.

Several officials, including Fed Chairman Ben S. Bernanke before he became chairman, have said their ``comfort'' zone for the Fed's preferred inflation gauge is 1 percent to 2 percent.

Fed officials have been studying ways they can better communicate their goals to the public and inflation targets have been discussed.

To contact the reporters on this story: Craig Torres in Washington at o ctorres3@bloomberg.net; Greg Quinn in Montreal at gquinn1@bloomberg.net.

Last Updated: October 20, 2007 13:00 EDT