Core Inflation
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Updated Nov 27, 2020
What Is Core Inflation?
Core inflation is the change in the costs of goods and services but does not include those from the food and energy sectors. This measure of inflation excludes these items because their prices are much more volatile. It is most often calculated using the consumer price index (CPI), which is a measure of prices for goods and services.
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Core Inflation
Understanding Core Inflation
Core inflation is measured by both the CPI and the core personal consumption expenditures index (PCE). The PCE represents the prices of goods and services purchased by consumers in the U.S. Since inflation is a measure of the trend in rising prices, PCE is an important metric in determining inflation. However, core PCE and CPI are similar, and both help to determine how much inflation is in the economy.
Other methods of calculating core inflation include the outliers method, which removes the products that have had the largest price changes. Core inflation is considered an indicator of underlying long-term inflation.
Why Food and Energy Prices Are Excluded
Food and energy prices are exempt from this calculation because their prices can be too volatile or fluctuate wildly. Food and energy are necessary staples, meaning demand for them doesn't change much even as prices rise. For example, gas prices may rise with the price of oil, but you will still need to fill up the tank in order to drive your car. Similarly, you won't be pushing off buying your groceries just because prices are rising at the store.
Also, oil and gas are commodities and are traded on exchanges where traders can buy and sell them. Food too is traded including wheat, corn, and pork. The speculation of energy and food commodities leads to volatility in their prices, causing wild swings in the inflation figures. For example, a drought can cause dramatic effects on the prices of crops. The effects on inflation can be brief, meaning they ultimately correct themselves and the market returns to a balanced state. As a result, food and energy prices for these goods are excluded from the calculation of core inflation. 
The Preferred Measure of Core Inflation
The Federal Reserve prefers to use the PCE index rather than CPI since PCE tends to provide inflation trends that are less affected by short-term price changes. Also, the Bureau of Economic Analysis (BEA), a division of the Department of Commerce, calculates the change of prices by using existing gross domestic product (GDP) data, which helps to determine an overall trend in prices. The GDP figure is a measure of the production of all goods and services in the U.S. The BEA also adds in the monthly Retail Survey data and compares them with the consumer prices provided by the CPI. These additions remove data irregularities and provide detailed long-term trends.
The Importance of Core Inflation
It is important to measure core inflation because it reflects the relationship between the price of goods and services and the level of consumer income. If prices for goods and services increase over time, but consumer income doesn't change, consumers will have less purchasing power. Inflation causes the value of money or income to decrease in comparison to the prices of basic goods and services.
However, if consumer income rises, called wage growth, while the prices of goods and services remain unchanged, consumers will have more purchasing power. Also, as investment portfolios and home prices rise, asset inflation occurs, which can provide additional money for consumers to spend.
Related Terms
Headline Inflation
Headline inflation is the raw inflation figure reported through the Consumer Price Index (CPI) that is released monthly by the Bureau of Labor Statistics.more
Inflation is a decrease in the purchasing power of money, reflected in a general increase in the prices of goods and services in an economy. more
Real Income Definition
Real income, also known as real wage, is how much money an individual or entity makes after accounting for inflation. more
Purchasing Power Definition
Purchasing power is the value of a currency in terms of the goods or services one unit of it can buy. Discover how purchasing power impacts investors.more
Consumer Price Index (CPI) Definition
The Consumer Price Index measures the average change in prices over time that consumers pay for a basket of goods and services. more
How the Trimmed Mean Is Used
A trimmed mean is a method of averaging that removes a small percentage of the largest and smallest values before calculating the mean. more
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