Core Inflation, Core Inflation Rate

Core inflation is a measure of inflation that excludes items such as food products and energy, which are prone to volatile price movements. The concept of core inflation rate was introduced by Robert J. Gordon in 1975.

Significance of Core Inflation

Core inflation is an indicator of long-term inflation at a fundamental level. It is considered while framing monetary policies, as it supports the primary goal of central banks – price stability along with sustainable economic output and employment. Core inflation does not consider products that are easily influenced by supply shocks. This is because such items can move away from the overall inflation trend and represent a false picture.

Measuring Core Inflation

Core inflation is calculated in various ways:

Outliers method: This excludes products that have the largest price changes.

• Statistical methods: These include trimmed mean and weighted mean. These methods are derived from a highest-to-lowest ranking of individual price changes for each given month.
• Consumer Price Index (CPI): This measures inflation and excludes the prices of volatile products such as food and energy.

Monitoring the Core Inflation Rate

In an economy facing inflationary pressure, the central bank typically aims at controlling the core inflation rate, as this is easier to control than the headline rate. Any change in the interest rate policy should consider core inflation, as an increase in the interest rate might hamper growth. This can further aggravate the inflationary situation.

Uses of Core Inflation

Core inflation serves three major purposes:

• Forecasting future inflation: Predictions of future inflation based on core measures are more accurate than predictions based on headline inflation.
• Measuring the current trend inflation rate: The inflation rate reflects both permanent and transitory components. By stripping away the short-term movements, the current trend inflationary rate can be measured more effectively.
• Stabilizing the economy: This is done by reducing variations in the output and employment.

Statistical agencies across the world typically use the core inflation rate as a supplement to the headline inflation rate and publish them together. The countries that use the core inflation rate as the operating base for monetary policies include Canada, the Czech Republic, Thailand, Finland and South Africa.