Core Inflation

Updated on January 25, 2024
Article byKhalid Ahmed
Reviewed byDheeraj Vaidya, CFA, FRM

What is Core Inflation? 

Core inflation refers to inflation based on the consumer price index (CPI), covering the inflation of all the goods and services except the volatile food & fuel prices, excise duties, income tax, and other financial investments. It guides the governments in forecasting long-term inflation trends for a country.

Core inflation Overview

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The Federal Reserve uses it for formulating the appropriate monetary policy. The Fed becomes active only when the core inflation rate is more than 2% than the previous year. Policymakers and economists use the consumer price index (CPI) and personal consumption expenditure (PCE) to calculate core inflation.

Key Takeaways

  • Core inflation meaning refers to the difference between inflation of all items in CPI and the inflation of food and petroleum.
  •  It is the best indicator of long-term inflation trends to prepare appropriate monetary policy for an economy.
  • Analysts do not calculate the food and petroleum prices because of their highly volatile prices in the commodities market. Therefore, the consumer price index (CPI) and personal consumption expenditure (PCE) together determine the core inflation of the USA. 
  • Headline inflation is less accurate than core inflation as it contains volatile priced items and is used mostly in developing countries and vice versa. 

Core Inflation Explained

Core inflation meaning describes the measurement of inflation using the consumer price index inflation minus the volatile and widely fluctuating food and petroleum prices. So, the calculation does not include food and fuel prices because their price changes rapidly in short periods.

CORE INFLATION GRAPH

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Video Explanation of Inflation

 
 

The following are the reasons for the volatility of price change of food and petroleum:

  • The trading of both items- food & energy- occurs in the commodities market.
  • Their trading keeps on going for the entire day.
  • Commodities traders may bid for petroleum prices in anticipation of impending war or calamity to sell them on the next day for profits. Consequently, the oil prices rise, and if their anticipated war or calamity fails to happen, they sell all their oil bids lowering the oil price.
  • Food prices depend on fuel prices, so it changes rapidly too.

Therefore, the Fed uses core inflation minus the food and oil prices to calculate current inflation to find the right inflation rate. It then predicts the long-term trend of inflation. The Fed uses PCE, the representation of the prices of goods and services, and CPI to predict the inflation of the United States economy. The US core inflation rate is 6.02% in 2022, which is higher than the 3.80% rate in 2021. 

The Bureau Of Labor Statistics determines CPI by creating an index based on a survey of more than seventy thousand customers. Analysts procure all the data from retailing and services-providing companies. The sample size consists of 14500 families. The Bureau of Economic Analysis (BEA) is responsible for reporting the price index of PCE core inflation

Core Inflation Key Role

It plays a key role in a gradual and disastrous economic impact. If the inflation rate is 1% to 2%, then the consumers will start buying goods and services, stimulating the economy’s growth. However, if it becomes too high and the salary does not increase, that may increase growth in essential commodities, excluding other products. Hence, some industries will increase their business, whereas the other sectors will have losses and may even close down permanently. As a result, the industrial output will decrease, and the economy will suffer. 

What Is Included In Core Inflation? 

Core inflation is a form of a consumer price index (CPI) that covers changes in prices of all goods except food prices, fuel prices, income tax & financial investments in USA markets. However, as a general rule, the food and petroleum prices are exempted from calculating this inflation. Moreover, other than these two, all other goods and services that it includes are:

  1. Electronics
  2. Real estate
  3. Transport
  4. Retail
  5. Pharmacy
  6. Aviation
  7. Airline fares
  8. Information technology 
  9. Telecom sector
  10.  Garments industry
  11.  Defense manufacturing
  12.  Sewer and water services
  13.  Excise along with excise taxes
  14.  Medical care
  15.  Education
  16.  New and used vehicles

These products are some basic essential requirements whose demand remain stable even if prices fluctuate. For example, transportation costs may rise with the rising price of diesel, but transportation of necessary products has to go on.

Bureau of Economic Analysis (BEA) and the Bureau of Labor Statistics (BLS) survey all these sectors to gather data on prices and then aggregate them in the form of a report to find the CPI of the nation. Moreover, economists and policymakers obtain this inflation after removing the price changes of food and oil.

Policymakers also use the outlier method to calculate this inflation. This method removes the products and services with the largest volatility while calculating. 

Example 

Here is a core inflation example to explain the concept clearly. 

According to the Consumer Price Index for all urban consumers of the Fed, the USA had all-item CPI-based inflation of 5% in 2019. Moreover, according to the calculation, the food and petroleum sector’s inflation was 2%.

So, when the policymakers deducted the CPI from the foods & energy sector from the all item-based CPI, the core inflation was pegged at 3%. Usually, the inflation level must be around 2%. Hence, the Fed decided to put various balances and checks on the bank rates to reduce inflation. As a result, the Federal Open Market Committee (FOMC) got into action to increase the rate and decrease inflation to achieve the target of long-term core inflation of 2%.

Core Inflation vs Headline Inflation

The macroeconomic phenomenon of inflation has multiple forms and impacts. Core inflation and headline inflation are two types of inflation that are similar yet quite different from each other.

Core InflationHeadline Inflation
Core inflation is inflation-related to all the commodities, goods, and services in the economy minus the volatile food prices and fuel prices.Headline inflation is inflation-related to all the economy’s commodities, goods, and services.
It is more stable than headline inflation due to the absence of volatile commodities like food and petroleum.The volatile food and petroleum prices are more volatile than the other inflation.
The developing nation uses it to calculate its inflation.The developed nation is ideal for the application of headline inflation.
Because of the developed economy, household consumption of fuel & food makes up almost 15% of the basket of average families.Developing nations have more than 40% of food and fuel consumption in the basket of average families.
It denotes the ongoing trends in the inflation of a country used by the state to design economic strategies for the future.It means the total inflation within an economy of a country.

Frequently Asked Questions (FAQs)

What is core inflation?

Core inflation assesses the changes in the prices of products and services, excluding those products and services which are seasonal like food and highly volatile products like petroleum. It also does not consider the excise duties imposed by the government. The consumer price index forms its base.

What is the core inflation rate?

The core inflation rate measures the inflation only for those not in the food and petroleum sectors like the electronic sector and information technology. At present, the rate is 6% as of May 2022.

How to calculate core inflation?

Economists, policymakers, and analysts can calculate the core inflation by using the formula below:
Core inflation, CI = change in the price of all goods and services (Psg) – change in the price of energy and food (Pef).
Or CI= Psg– Pef

What is core CPI inflation?

Core CPI inflation is Consumer Price Index, but only the extremely volatile goods and services are removed from it.

This has been a guide to what is Core Inflation and its meaning. Here we discuss its key role, what is included in it along with its example and differences from headline inflation. You may learn more about financing from the following articles –

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Comments

  1. Gogo says

    It was helpful thank you!

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