The core inflation rate measures inflation only for those not active in the food and oil sectors, such as electronics and information technology. Currently, the rate is 6% in May 2022. The Fed uses inflation targets. It would prefer not to act if the core inflation rate is 2% lower than last year. The core inflation rate for August 2022 was 6.3% year-on-year. This means that prices for everything but food and energy have risen 5.9% since August 2021. The rate in August was higher than expected by economists. The base rate excludes food and energy prices because the prices of these products vary too much from month to month and can distort the higher inflation rate. Economists have tried to find the best measure of core inflation according to various criteria. See Timothy Cogley, “A Simple Adaptive Measure of Core Inflation,” Journal of Money, Credit and Banking, Vol. 34, no. 1, February 2002, pp. 94-113; Danny Quah; Shaun P.
Vahey, “Measuring Core Inflation,” The Economic Journal, Vol. 105, No. 432, September 1995, pp. 1130-1144; Michael Bryan and Stephen Cecchetti, “Measuring Core Inflation,” in N. Gregory Mankiw, ed., Monetary Policy, (Chicago: University of Chicago Press, 1994), p. 195; Todd Clark, “Comparing Measures of Core Inflation,” Federal Reserve Bank of Kansas City, Economic Review, 2002: 2, p. 5. 1. To illustrate the importance of the objective of price stability, it should be noted that the Federal Open Market Committee recently discussed the issue of inflation targeting, which sets the monetary policy of a central bank with the aim of maintaining a certain level of inflation (see the FOMC minutes of the February 2, 2005 meeting: www.federalreserve.gov/FOMC/minutes/20050202.htm). Most discussions on inflation targeting recommend aiming for a core inflation rate.
Ultimately, the question of which level of inflation is best suited for policy-making is empirical. One study found that “no basic measure does an excellent job of forecasting [headline] CPI inflation. We find no valid evidence that a selected baseline measure will be able to maintain its usefulness as an inflation forecasting tool for a given period of time. 11 Another study found no statistically significant relationship between core inflation and future headline inflation, although the relationship becomes significant when limited to a more recent period.12 Two other studies found that: that headline inflation is a better predictor of future headline inflation than core inflation.13 One reason for this finding is that changes in core inflation over the course of the The last 10 years have tended to lag behind changes in headline inflation, as shown in Figure 1. One study found that a basic measure that excludes only energy is a better predictor of future inflation from 1983 to 2001 than a measure that excludes food and energy. In fact, this study found that food prices are a better predictor of future inflation than any other measure, including core inflation.14 Some studies suggest that there may be more sophisticated measures that provide a better measure of underlying inflationary pressures than the standard definition of core inflation.15 From a policy perspective, Core inflation has the following advantage: However, to be transparent, while more sophisticated measures might be difficult for the public to understand and open to allegations of data mining or manipulation. While this advantage may make core inflation a useful tool for communicating Fed policy to the public, empirical evidence suggests that it is in itself an inadequate tool for policy-making. Measuring core inflation is essential because it reflects the relationship between the prices of goods and services and the income level of consumers. If the prices of goods and services increase over time, but consumer incomes do not change, consumers will have less purchasing power. Inflation causes the value of money or income to fall relative to the prices of basic goods and services. Ideally, policymakers want to be able to see if a change in inflation was driven by demand or supply. Unfortunately, there is no easy way to do this, so they have often used core inflation as an indicator of demand-driven inflation, arguing that food and energy are the two sectors of the economy most vulnerable to supply shocks.
In addition, policymakers are particularly concerned about inflation expectations, and a rise in the base rate may be a better sign of this than the growing headline that inflation expectations have risen. Although the exclusion of food from core inflation has become conventional, it may no longer be justified. Food volatility has declined significantly since the 1970s.7 Until 2007, the most recent divergence between headline and core inflation was due to energy prices. In 2007, food prices rose rapidly – it is too early to say whether this development marks a new period of sustained volatility. When food prices are no longer volatile, policymakers can lose useful information by omitting it. The Bureau Of Labor Statistics determines the CPI by creating an index based on a survey of more than seventy thousand customers. Analysts get all the data from retail and service companies. The sample size consists of 14500 families. The Bureau of Economic Analysis (BEA) is responsible for reporting on the core PCE inflation price index. The rate of core inflation is the change in the price of goods and services minus food and energy. Food and energy products are too volatile to absorb. They change so quickly that they can give an accurate reading of the underlying trends of inflation.
2. The average increases over the entire twenty-year period shown in Figure 1 were 3.2% for the core CPI, but only 2.4% for energy prices. However, the annual variation in all prices, represented by a blue line, has been narrow, ranging from a low of 1% to a peak of 6%, while the annual variations in energy prices have been much larger, ranging from a low of almost -20% to a peak of almost 24%. Economists, policymakers and analysts can calculate core inflation using the following formula: Core inflation, CI = change in the price of all goods and services (Psg) – change in the price of energy and food (Pef). Or IC = Psg – Pef Core inflation is measured by both the CPI and the CORE PERSONAL Consumer Spending (PCE) index. The ECP represents the prices of goods and services purchased by consumers in the United States. Since inflation is a measure of the upward trend in prices, the PCE is an important measure for determining inflation. However, the PCE and the core CPI are similar and both help determine the level of inflation in the economy. Core inflation is used by policymakers for the reason cited by President Bernanke in the introduction – policymakers are most concerned about the future path of inflation, and current data on core inflation could provide better information than current aggregate data on future headline inflation.
Headline inflation often does not have good predictive power over short periods of time because food and energy prices are so volatile. For example, in 2006, the overall monthly inflation rate fluctuated between -6.3% and 7.5% at annualized rates, while the base rate fluctuated between 1.2% and 3.6%.8 Policymakers are concerned about future inflation because there are delays between a policy change and its impact on the economy. Essentially, it is already too late for policymakers to influence current inflation, a change in policy today can only affect future inflation. The PCE price index gives a better indication of the underlying performance of inflation than the core CPI. It is less volatile, thanks to the way it is measured. In scenarios like this, the focus on core inflation could prevent a necessary policy shift until it is too late. Indeed, it can be argued today that a greater focus on headline inflation would have avoided the sustained upward trend in core inflation that occurred from 2003 to 2007 and would have placed core inflation above the Fed`s self-defined “comfort zone.” The weakness of the focus on core inflation is that when energy prices rise continuously over a period of several years, it is no longer random price fluctuations that do not provide useful information about future inflation.