Core Inflation

About Core Inflation

• It is the change in the costs of goods and services excluding the price variations in seasonal elements, such as those related to food and energy.
• Food and energy prices are exempt from this calculation because their prices can be too volatile or fluctuate wildly.
• Core inflation represents the long-term trend in the price level.
• Why is it important?
  • It is used to determine the impact of rising prices on consumer income.
  • To deal with such situations, many central banks use measures of core inflation that are designed to filter transitory price movements.
  • If the increase in the price index is due to temporary shocks that could soon reverse themselves, it may not require any monetary policy action.
  • On the other hand, prices of other commodities do not fluctuate as regularly as those of food and fuel: as such, increase in their prices could be taken relatively to be much more of a permanent nature.
  • It follows logically for Central Banks to target only core inflation, as it reflects the demand-side pressure in the economy. 
  • Core inflation, by eliminating the volatile components from the headline helps in identifying the underlying trend in headline inflation and is believed to predict future inflation better.
  • It is a convenient guide to help the central bank achieve its objective of controlling total inflation.
  • Whenever core inflation rises, Central Banks increase their key policy rates to suck excess liquidity from the market, and vice versa. It is, therefore, a preferred tool for framing long-term policy.

What is Headline Inflation?

• Headline inflation is the total inflation in an economy.
• It is the raw inflation figure reported through the Consumer Price Index (CPI).
• The headline inflation figure includes inflation in a basket of goods that includes commodities like food and energy.
• It is different from core inflation, which excludes food and energy prices while calculating inflation.

Q1) What is Deflation?

Deflation is a general decline in prices for goods and services, typically associated with a contraction in the supply of money and credit in the economy. During deflation, the purchasing power of currency rises over time.

Source: Core inflation to stay around 3% till Q1 FY25: Economists