Economists distinguish between two key inflation measures: headline inflation and core inflation. Understanding both headline and core inflation provides a more nuanced view of inflationary pressures in an economy. Each measure serves a different purpose for policymakers and analysts.
Headline Inflation: This is the most widely reported measure, capturing the overall change in the price of a basket of goods and services, including volatile components like food and energy prices. Headline inflation measures the total inflation within an economy, including commodities such as food and energy prices (e.g., oil and gas), which tend to be more volatile and prone to inflationary spikes.
Challenges:
- Sector-specific inflationary spikes, particularly in food and energy, can distort the overall inflation trend.
- Due to this volatility, headline inflation may not present an accurate picture of the economy’s long-term inflationary trend.
Global Focus:
- Institutions like the European Central Bank and the Bank of England set their inflation goals based on headline inflation.
- India also emphasizes headline inflation in its economic assessments.
Core Inflation: This measure aims to isolate the underlying trend of inflation by excluding the more volatile food and energy components from the Consumer Price Index (CPI) or Personal Consumption Expenditures (PCE) index. Core inflation, also known as non-food-manufacturing or underlying inflation, is calculated from a consumer price index excluding volatile food and energy components.
Headline vs. Core Inflation: Understanding the Differences
- Focus: Headline inflation reflects the immediate impact of price changes on consumers, while core inflation provides a clearer picture of long-term inflationary trends.
- Volatility: Headline inflation can be more volatile due to fluctuations in food and energy prices. Core inflation is generally less volatile, offering a more stable signal for policymakers.
- Policy Decisions: While some central banks, like the European Central Bank and the Bank of England, target headline inflation, others, like the Federal Reserve in the US, primarily focus on core inflation when making monetary policy decisions.
The Case of the US Federal Reserve
The US Federal Open Market Committee (FOMC) prioritizes core inflation as measured by the Personal Consumption Expenditures Price Index (PCE). However, they also acknowledge the importance of headline inflation and factor it into their analysis. This reflects the Fed’s ultimate concern with long-term price stability and the impact on consumers. Since the 2008 financial crisis, the FOMC includes forecasts for both headline and core inflation in its semiannual “Monetary Policy Report” to the United States Congress.