Core inflation

Core inflation

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Core inflation is a measure of inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...

 which excludes certain items that face volatile price movements, notably food and energy.

The preferred measure by the Federal Reserve of core inflation in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...

 is the core Personal consumption expenditures price index
Personal consumption expenditures price index
The PCE price index is a United States-wide indicator of the average increase in prices for all domestic personal...

 (PCE). This is based on chained dollars
Chained dollars
Chained dollars is a method of adjusting real dollar amounts for inflation over time, so as to allow comparison of figures from different years. The U.S. Department of Commerce introduced the chained-dollar measure in 1996...

.


Since February 2000, the Federal Reserve Board’s semiannual monetary policy reports to Congress have described the Board’s outlook for inflation in terms of the PCE. Prior to that, the inflation outlook was presented in terms of the CPI. In explaining its preference for the PCE, the Board stated:

The chain-type price index for PCE draws extensively on data from the consumer price index but, while not entirely free of measurement problems, has several advantages relative to the CPI. The PCE chain-type index is constructed from a formula that reflects the changing composition of spending and thereby avoids some of the upward bias associated with the fixed-weight nature of the CPI. In addition, the weights are based on a more comprehensive measure of expenditures. Finally, historical data used in the PCE price index can be revised to account for newly available information and for improvements in measurement techniques, including those that affect source data from the CPI; the result is a more consistent series over time.

—Monetary Policy Report to the Congress,
Federal Reserve Board of Governors,
Feb. 17, 2000


Previously the Federal Reserve had used the US Consumer Price Index as its preferred measure of inflation. The CPI is still used for many purposes, for example, for indexing social security. The equivalent of the CPI is also commonly used by central banks of other countries when measuring inflation. The CPI is presented monthly in the US by the Bureau of Labor Statistics.
This index tends to change more on a month to month basis than does "core inflation". This is because core inflation eliminates products that can have temporary price shocks (i.e. energy, food products).
Core inflation is thus intended to be an indicator and predictor of underlying long-term inflation.

History


The concept of core inflation as aggregate price growth excluding food and energy
was introduced in a 1975 paper by Robert J. Gordon
Robert J. Gordon
Robert James "Bob" Gordon is an American economist. He is the Stanley G. Harris Professor of the Social Sciences at Northwestern University. He is known for his work on productivity, growth, the causes of unemployment, and airline economics.-Education:...

. This is the definition of "core inflation" most used for political purposes.
Core inflation was also developed and advocated by Otto Eckstein
Otto Eckstein
Otto Eckstein was a German-born economist at Harvard University, member of the President's Council of Economic Advisers from 1964 to 1968), and co-founder of Data Resources Inc. He received an A.B. from Princeton University and a Ph.D...

, in .

Moving average


Analysis by the Federal Reserve Bank of New York
Federal Reserve Bank of New York
The Federal Reserve Bank of New York is one of the 12 Federal Reserve Banks of the United States. It is located at 33 Liberty Street, New York, NY. It is responsible for the Second District of the Federal Reserve System, which encompasses New York state, the 12 northern counties of New Jersey,...

 indicates that this measure is no better than a moving average of the Consumer Price Index
Consumer price index
A consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of...

 as a predictor of inflation.

Trimming



There are also other types of measuring inflation rates. In the United States the Dallas Federal Reserve computes a trimmed mean PCE price index, which separates "noise" and "signal". This is trimmed at 19.4% at the lower tail end and 25.4% at the upper tail. The Cleveland Federal Reserve computes a Median
Median
In probability theory and statistics, a median is described as the numerical value separating the higher half of a sample, a population, or a probability distribution, from the lower half. The median of a finite list of numbers can be found by arranging all the observations from lowest value to...

 CPI and a 16% trimmed mean CPI. Trimmed means that the highest rises and declines in prices are trimmed by a certain percentage, attributing to a more accurate measurement on core inflation.

In relation to this, the Median CPI is usually higher than the trimmed figures for both PCE and CPI. There also is a median PCE, but is not widely used.

External links

  • Core Inflation: A Review of Some Conceptual Issues, Mark A.Wynne, Federal Reserve Bank of St. Louis Review, May/June 2008
  • OECD inflation statistics
  • Core Logic, Paul Krugman
    Paul Krugman
    Paul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...

    , February 26, 2010 – explanation of concept and motivation