Core inflation is kicked around a lot when inflation is discussed in the news media and in relation to the Federal Reserve. What exactly is core inflation?
First, a short discussion of inflation is in order. Inflation is described as the general increase in the price of something. In the United States, each month the U.S. Labor Department publishes through its Consumer Price Index (CPI) report the amount of change for prices of certain goods and services it monitors like grocery products, gasoline, electricity, medical care, vehicles, etc. It offers monthly and annual changes for these items, to include the latest inflation rates that average the changes across them all.
Back to core inflation… Core inflation discounts or strips out certain categories that are considered more volatile. The monthly and annual core inflation figures, also published by the U.S. Labor Department, strips all the energy products and all the food products. The bureau does not specifically call the results "core inflation" in the monthly CPI reports. That is a term for economists and how they describe it. Instead, it will say: "index for all items less food and energy," and provide the percentage amounts. It lists the core monthly and annual inflation rates, just like it does for standard inflation described earlier.
So, why does the U.S. Labor Department strip energy and food prices and report them? Core inflation is a more stable inflation reading that fluctuates less from uncontrollable circumstances, offering a better "apples to apples" comparison over time. In short, it is used by economists to exclude seasonal and other factors that can skew inflation.
For example, if a drought hits a large area and causes food prices to skyrocket for a short period, the standard inflation rate reported takes this into account while the core inflation rate does not. The same is true if gasoline prices rise for a short period do to tightening supplies, like often happens in summer months when motorists use more gas or in a disruptive hurricane season when drilling rigs shut down in the Gulf.
Economists focus on core inflation to help set monetary policy for the longer term, for example, like the Federal Reserve’s benchmark interest rate. The Fed’s Federal Open Market Committee (FOMC) currently has a core annual inflation rate of 2.0% as its target. This core rate level is what the Fed believes is best for a strong economy.
Americans that are not economists are attuned to inflation without the exclusions as the everyday items, to include gas and food prices, affect their paychecks. If the core inflation rate was at the Fed’s targeted 2.0% while grocery and energy prices jumped through the roof, there would be no public support in hearing that inflation is where it should be.