Definition of Core Inflation

Core inflation is a change in the costs of goods and services, but it does not include those related to the food and energy sectors. This measure of inflation excludes these items because their prices are more volatile. It is typically calculated using the Consumer Price Index (CPI), which is a measure of the prices of goods and services.

Understanding Core Inflation

Core inflation is measured by both the Consumer Price Index (CPI) and the Core Personal Consumption Expenditures (PCE) index. The Core Personal Consumption Expenditures index represents the prices of goods and services that consumers buy in the United States. Since inflation is a measure of the trend in rising prices, the Core Personal Consumption Expenditures index is an important measure in determining inflation. However, the Core Personal Consumption Expenditures index and the Consumer Price Index are similar, and both help determine the extent of inflation in the economy.

The Importance of Excluding Food and Energy Prices

Food and energy prices are excluded from this calculation because their prices can be very volatile or fluctuate significantly. Food and energy are essential commodities, meaning that the demand for them does not change much even when prices rise. For example, fuel prices may rise with increasing oil prices, but you will still need to fill your gas tank to drive your car. Similarly, you won’t delay your grocery shopping just because prices are rising at the store.

Furthermore, oil and gas are tradable commodities and are traded on exchanges where traders can buy and sell them. Food is also traded, including wheat, corn, and pork. Speculation in food and energy commodities leads to price fluctuations, resulting in significant volatility in inflation figures. For example, drought can have dramatic effects on crop prices. The effects of related inflation can be short-term, meaning they eventually correct themselves, and the market returns to a balanced state. As a result, food and energy prices are excluded from the core inflation calculation.

The Preferred Measure of Core Inflation

The Federal Reserve prefers to use the Core Personal Consumption Expenditures index instead of the Consumer Price Index because the Core Personal Consumption Expenditures index tends to provide inflation trends that are not influenced by short-term price changes. Also, the Bureau of Economic Analysis (BEA), which is part of the Department of Commerce, calculates price changes using current Gross Domestic Product (GDP) data, which helps determine an overall trend in prices. The GDP figure is a measure of the production of all goods and services in the United States. The Bureau of Economic Analysis also adds data from the monthly retail survey and compares it to the consumer prices provided by the Consumer Price Index. These additions remove data irregularities and provide detailed long-term trends.

The Importance of Core Inflation

Measuring core inflation is crucial as it reflects the relationship between the price of goods and services and the consumer income level. If the prices of goods and services rise over time but consumer income does not change, consumers will have less purchasing power. Inflation causes a decrease in the value of money or income relative to the prices of essential goods and services.

However, if consumer income, referred to as wage growth, rises while the prices of goods and services remain stable, consumers will have more purchasing power. Inflation occurs in investment portfolios and home prices, leading to asset inflation, which can provide additional money for consumers to spend.

What is Purchasing Power?

Purchasing power is the value of currency expressed in terms of the number of goods or services that one unit of money can buy. Purchasing power is important because inflation, all else being equal, reduces the number of goods or services you can purchase.

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In terms of investment, purchasing power is the amount of money available to a client for purchasing additional securities against the current margin securities in the brokerage account. Purchasing power can also be defined as the currency’s buying power.

What is volatility?

Volatility is a statistical measurement of the dispersion of returns for a specific security or market index. In most cases, the higher the volatility, the greater the risk in the security. Volatility is often measured as either standard deviation or variance between the returns of the same security or market index.

What is GDP (Gross Domestic Product)?

Gross Domestic Product (GDP) is the total monetary value or market value of all finished goods and services produced within the borders of a country in a specified time period. It is also a comprehensive measure of the total domestic production of a specific country and serves as a comprehensive scorecard of the economic health of that country.

Although GDP is typically calculated on an annual basis, it is sometimes calculated quarterly as well. In the United States, for example, the government releases an annual estimate of GDP for each financial quarter and also for the calendar year. The individual data sets included in this report are presented in real numbers, so the data is adjusted for price changes and thus is net of inflation.

Source: https://www.investopedia.com/terms/c/coreinflation.asp