Why do we employ core-inflation?

The econometrics used by analyst can become very complex as mountains of data points are added to the statistical analysis.

Key Concepts

Today, most economists agree on a fundamental concept: “core inflation should be a good indicator of the underlying inflation trend.” What this means is that core inflation should provide much of the information on the primary trend from the Consumer Price Index (CPI) data. Furthermore, core inflation can be used as a trajectory of overall price change expected to persist for a period of time.

Another important concept related to core inflation is that it should capture just the component the of the price change that is common to all data points included in the CPI. On the long run prices of individual goods and services more often than do not rise along with the fundamental trend of prices in the economy. Nonetheless, some item prices might rise at a higher trend rate. while others might increase at below the trend rate or even drop. These differences in rates of change reflect shifts in the prices of relative supply and demand whilst core inflation should be abstracted from such relative price changes and single out the common component to all price variations.

Key Measurements

Based on these concepts, economist have proposed a number of different core inflation econometrics to exclude the same fixed set of components from each month’s overall CPI, even when the change is not large for a given month. Another method is to remove from a month’s overall inflation rate the components affected by large price swings in just that month. These are the two basic methods and categories used by analysts in a month’s of observation metrics.

Weights are used which correspond to the relative importance of the components in the CPI, however the weights given to the components included in the core inflation measure should add up to 1. The relative weight is based on consumer expenditures, measured in terms of quantities purchased in a base period of the CPI. Therefore, the most commonly used measure of core inflation in the CPI excludes food and energy.

VOLATILITY OF CPI PRINCIPAL COMPONENTS

1. Fuel oil and other household fuel commodities 87.2

2. Motor fuel 34.7

3. Meats, poultry, fish, and eggs 31.1

4. Fruits and vegetables 26.4

5. Infants’ and toddlers’ apparel 22.6

6. Public transportation 19.0

7. Used cars 17.1

8. Other apparel commodities 13.4

9. School books and supplies 11.0

10. Other food at home 10.8

11. Tobacco and smoking products 10.7

12. Other private transportation commodities 10.2

**Source: Bureau of Labor Statistics**