Core inflation represents the long run trend in the price level. In measuring long run

inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reductio ...

, transitory price changes should be excluded. One way of accomplishing this is by excluding items frequently subject to volatile prices, like food and energy.

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 James Gordon is an American economist. He is the Stanley G. Harris Professor of the Social Sciences at Northwestern University. Gordon is one of the world’s leading experts on inflation, unemployment, and long-term economic growth. His ...

. This is the definition of "core inflation" most used for political purposes. The core inflation model was subsequently developed and advocated by

Otto Eckstein Otto Eckstein (August 1, 1927 – March 22, 1984) was a German-American economist. He was a key developer and proponent of the theory of core inflation , which proposed that in determining accurate metrics of long run inflation, the transitory pri ...

, in a paper published in 1981. According to the economic theory historian Mark A. Wynne, "Eckstein was the first to propose a formal definition of core inflation, as the 'trend rate of increase of the price of aggregate supply.'”

Usage

The preferred measure by the

Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...

of core inflation in the

United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territorie ...

is the change in the core

personal consumption expenditures price index The PCE price index (PePP), also referred to as the PCE deflator, PCE price deflator, or the Implicit Price Deflator for Personal Consumption Expenditures (IPD for PCE) by the Bureau of Economic Analysis (BEA) and as the Chain-type Price Inde ...

(PCE). This index is based on a dynamic consumption basket. Economic variables adjusted by this price deflator are expressed in

chained dollars Chained dollars is a method of adjusting real dollar amounts for inflation over time, to allow the comparison of figures from different years. The U.S. Department of Commerce introduced the chained-dollar measure in 1996. It generally reflects doll ...

, rather than the alternative constant-dollar measure based on a fixed goods' basket.

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 PCE index 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 The United States Consumer Price Index (CPI) is a set of consumer price indices calculated by the U.S. Bureau of Labor Statistics (BLS). To be precise, the BLS routinely computes many different CPIs that are used for different purposes. ...

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.

Alternatives to the core inflation model

There are other ways of measuring inflation rates.

Trimming

trimmed mean A truncated mean or trimmed mean is a statistical measure of central tendency, much like the mean and median. It involves the calculation of the mean after discarding given parts of a probability distribution or sample at the high and low end ...

PCE price index, which separates "noise" and "signal" 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 the United States, the Dallas Federal Reserve computes trimming at 19.4% at the lower tail end and 25.4% at the upper tail.

Moving average

In 2006, an analysis by the

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 responsible for the Second District of the Federal Reserve System, which encompasses the State of New York, the 12 northern counties of New ...

indicated that as a measure, core inflation was no better than a

moving average In statistics, a moving average (rolling average or running average) is a calculation to analyze data points by creating a series of averages of different subsets of the full data set. It is also called a moving mean (MM) or rolling mean and is ...

of the

Consumer Price Index A consumer price index (CPI) is a price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time. Overview A CPI is a statistica ...

or CPI as a predictor of inflation.

Median CPI and median PCE

The Median CPI is usually higher than the trimmed figures for both PCE and CPI. The Cleveland Federal Reserve computes a

Median In statistics and probability theory, the median is the value separating the higher half from the lower half of a data sample, a population, or a probability distribution. For a data set, it may be thought of as "the middle" value. The basic fe ...

CPI and a 16% trimmed mean CPI. There also is a median PCE, but it is not widely used as a predictor of inflation.

References

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 statisticsCore Logic

Paul Krugman Paul Robin Krugman ( ; born February 28, 1953) is an American economist, who is Distinguished Professor of Economics at the Graduate Center of the City University of New York, and a columnist for ''The New York Times''. In 2008, Krugman was th ...

, February 26, 2010 – explanation of concept and motivation {{DEFAULTSORT:Core Inflation Inflation