Core inflation

Core inflation refers to the measure of inflation that excludes certain volatile items, such as food and energy prices, to provide a clearer picture of the underlying, long-term trend in price changes.
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Updated on Jun 6, 2024
Reading time 4 minutes

3 key takeaways

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  • Core inflation excludes volatile items like food and energy prices, offering a more stable measure of long-term inflation trends.
  • It helps central banks and policymakers in setting monetary policy by focusing on the underlying inflationary pressures in the economy.
  • Core inflation is considered more reliable for long-term economic planning and analysis than headline inflation, which includes all items.

What is core inflation?

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Core inflation is an adjusted measure of inflation that removes the effects of certain volatile components, typically food and energy prices, from the overall consumer price index (CPI). This adjustment provides a clearer view of the persistent, underlying inflation trends without the short-term fluctuations caused by these volatile items.

Key components excluded in core inflation:

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  • Food Prices: Often subject to seasonal changes, weather conditions, and supply chain disruptions.
  • Energy Prices: Includes items like gasoline and heating oil, which can be highly volatile due to geopolitical events, natural disasters, and other factors.

Example:

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If the overall CPI indicates a 4% inflation rate, but food and energy prices have spiked due to a temporary disruption, core inflation might show a lower rate, such as 2%, reflecting the more stable price changes excluding these volatile items.

Importance of core inflation

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  • Monetary Policy: Core inflation provides a more stable basis for setting monetary policy, as it filters out the noise from temporary price shocks.
  • Economic Stability: By focusing on core inflation, policymakers can better gauge the underlying inflationary pressures and implement measures to maintain economic stability.
  • Long-term Planning: Businesses and investors use core inflation to make more accurate long-term economic decisions and forecasts.

Advantages and disadvantages of core inflation

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Advantages:

  • Stability: Provides a more stable and reliable measure of inflation by excluding highly volatile components.
  • Policy Making: Helps central banks set interest rates and other monetary policies more effectively.
  • Economic Insight: Offers a clearer picture of the true inflation trend, aiding in economic analysis and decision-making.

Disadvantages:

  • Exclusion of Important Items: By excluding food and energy, it may overlook significant cost-of-living changes for consumers.
  • Potential Misinterpretation: Some may argue that excluding volatile items can lead to a misrepresentation of the actual inflation experienced by consumers.
  • Lagging Indicator: Core inflation may not reflect immediate economic changes, making it less responsive to short-term economic conditions.

Real-world application

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Core inflation is widely used by central banks and policymakers around the world to guide monetary policy and economic analysis:

  • Central Banks: Institutions like the Federal Reserve (USA) and the European Central Bank (ECB) monitor core inflation to set interest rates and manage economic stability.
  • Economic Forecasting: Economists use core inflation to predict future inflation trends and economic conditions.
  • Business Planning: Companies use core inflation data to make long-term strategic decisions regarding pricing, wages, and investments.

Practical Examples:

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  • Federal Reserve: The Fed targets a 2% core inflation rate as part of its dual mandate to promote maximum employment and stable prices.
  • European Central Bank: The ECB monitors core inflation closely to ensure price stability within the Eurozone.
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  • Headline inflation
  • Consumer price index (CPI)
  • Monetary policy
  • Inflation targeting
  • Economic indicators
  • Price stability

Understanding core inflation is crucial for accurately assessing economic conditions and making informed decisions regarding monetary policy and long-term economic planning. By focusing on the underlying trends in price changes, core inflation provides a more stable and reliable measure of inflationary pressures in the economy.


Sources & references

Arti

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Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the Invezz.com knowledge base, understands over 100,000 Invezz related data points, has read every piece of research, news and guidance we\'ve ever produced, and is trained to never make up new...