Core Inflation - Explained
What is Core Inflation?
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Table of ContentsWhat is Core Inflation?Why is Core Inflation Important? Why Food and Energy Aren't Included in Core InflationA New Measure for Core InflationAcademic Research on Core Inflation
What is Core Inflation?
Core inflation is a measure of inflation that captures changes in the price of goods and services, excluding food and energy. Core inflation measures long-run inflation and excludes items such as food and energy because their prices change frequently due to a high level of volatility. This inflation only accounts for changes in the cost of goods and services.
Why is Core Inflation Important?
Generally, core inflation is considered to be an indicator of long-term inflation in an economy. The consumer price index (CPI) and the core personal consumption expenditures index (PCE) are the common metrics used in calculating core inflation. Products that are frequently subjected to price volatility such as food and energy items are excluded from the calculation. Prices of goods and services have the least price changes given that there some core factors that cause a change in their prices.
The importance of core inflation are highlighted below;
- Core inflation is an indicator of long-term inflation in an economy.
- This inflation shows the relationship between consumers' income and the prices of goods and services. In the sense that when prices of goods and services increase, the purchasing power of consumers will decrease because the value of their income is lower than the changes in prices of goods and services.
- Core inflation provides an accurate picture of inflation trends in an economy.
Why Food and Energy Aren't Included in Core Inflation
Core inflation aims to give an accurate picture of long-term inflation trends in an economy, to achieve this, accurate data must be used. Core inflation only captures price changes of goods and services and excludes food and energy because the latter has a high degree of price volatility. If the price change of food and energy is captured, core inflation might be less accurate. Food and energy are staples and encounter frequent price changes which do not necessarily mean the demand would also change. For instance, if you need to fill a particular kg of cooking gas for a month and the price changes, this will not change the kg of cooking gas that is needed for the month. The same applies to groceries, cereals, tubers and other food items that a household needs for a period of time.
A New Measure for Core Inflation
A new measure for core inflation emerged in 2012, this is not entirely different from the existing measure, only that the Federal Reserve decided to use the PCE index rather than the CPI index. The Federal Reserve argued that the inflation trends provided by the core personal consumption expenditures index (PCE) are less affected by short-term price changes unlike those of the consumer price index (CPI).
Academic Research on Core Inflation