Core inflation

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Core inflation is a measure of inflation which excludes certain items that face volatile price movements.

The preferred measure by the Federal Reserve of core inflation in the United States is the core Personal consumption expenditures price index. This is based on chained dollars.

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

The core PCE price index measure also has proved to be more accurate and consistent in measuring and predicting inflation over the core Consumer Price Index.

The older preferred measure of inflation in the United States was the Consumer Price Index. This is still used as the indicator for most other countries, and 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.

The concept of core inflation as aggregate price growth excluding food and energy was introduced in a 1975 paper by Robert J. Gordon. This is the definition of "core inflation" most used for political purposes.

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 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 used for any purpose in determining inflation.

Analysis by the Federal Reserve Bank of New York indicates that this measure is no better than a moving average of the Consumer Price Index as a predictor of inflation. (Citation needed)

Current Inflation Rates as of December 2006 (year-over-year):

Personal Consumption Expenditures Price Index- Overall - 2.3% Core - 2.2% Trimmed Mean - 2.5%

Consumer Price Index - Overall 2.1% Core - 2.7% 16% Trimmed Mean - 2.6% Median (100% trimmed) - 3.6% Chained Core - 2.3% (Chairman Bernanke stated chained core CPI, is a better more accurate measure for measuring inflation in terms of CPI).

[edit] References

Gordon, Robert J. (1975). "Alternative Responses of Policy to External Supply Shocks". Brookings Papers on Economic Activity 6 (3): 183-206.
Robert Rich, Charles Steindel (2005). "A Review of Core Inflation and an Evaluation of Its Measures (Staff Report, Federal Reserve Bank of New York)".

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