Measuring Inflation: Headline, Core and “Supercore” Services

Price stability is a fundamental mission of monetary policy, because inflation—a rise in the general price level—that is greater than fairly low levels distorts economic decisions and makes people worse off. To stabilize prices, central banks must measure aggregate price changes. There are many measures of aggregate price changes that differ in what prices they cover and how much weight each price category has.

The following FRED chart shows three of the most important inflation measures: the consumer price index (CPI), the personal consumption expenditures price index (PCEPI) and the gross domestic product (GDP) deflator. The Bureau of Labor Statistics publishes the CPI, while the Bureau of Economic Analysis publishes the PCEPI and the GDP deflator.

The CPI and PCEPI both measure the cost of living, but the PCEPI basket of goods and services is broader than that of the CPI, which measures the cost of living for an urban consumer. The weights on product categories in the baskets also differ, and the CPI famously weights the cost of housing more than does the PCEPI. Because the PCEPI weights are revised more often than CPI weights, the PCEPI better measures inflation when consumers are changing their buying habits in response to rapidly changing relative prices. The first chart shows that CPI and PCEPI inflation are highly correlated, but CPI inflation has exceeded that of the PCEPI by 30 basis points to 50 basis points per year over long periods because of differences in construction.

The third measure in the first chart, the GDP deflator, is a weighted average of the prices of all goods produced in the United States. The GDP deflator appropriately measures changes in prices of U.S. output, but not the cost of living for individuals, partly because it includes many goods that consumers do not directly buy and partly because it does not include import prices.

As the most widely watched measure of inflation, the CPI is used for many purposes, such as indexing Social Security payments. The Federal Open Market Committee has targeted inflation in the PCEPI since the 1990s, however, and made that index its official inflation target in January 2012.

The standard CPI and PCEPI measures of inflation shown in the first chart are often called “headline” inflation rates, in contrast to “core” measures of inflation—core CPI and core PCEPI—that exclude the direct contributions of energy and food prices. Core inflation is often described as a measure of “underlying” or “trend” inflation. Energy and food were considered particularly volatile when core measures were developed, so excluding them was thought to provide a less-noisy measure of inflation.Other measures of inflation—median or trimmed means—use statistical procedures to exclude particularly volatile prices, not prices that have a history of past volatility. The New York Fed’s Applied Macroeconomics and Econometrics Center constructs a measure of core-trend inflation with sophisticated statistical techniques that seek to model the persistent component of inflation.

The FRED chart below shows CPI inflation, ordinary core CPI inflation and another measure of core inflation published by the Atlanta Fed: sticky price CPI less food and energy. The sticky price index is a weighted basket of CPI components that change price relatively slowly, and the core version plotted here omits food and energy prices.

The purported role of core inflation as describing a less-noisy measure of inflation suggests that it predicts future inflation well, or better than headline inflation. Indeed, recent analysis from the St. Louis Fed’s Michael McCracken and Trần Khánh Ngân finds that core inflation does predict future inflation as well as or better than other measures of inflation. Still, if the goal is to predict future inflation, an explicit forecast that uses all kinds of information, such as news about future disruptions of commodities markets or fiscal policy, is likely to outperform any measure of current inflation as a forecast. Therefore, it doesn’t make much sense to compute core inflation simply to forecast future inflation, even if it outperforms headline inflation in that respect.

A better explanation of the usefulness of core inflation might be that it implicitly estimates the source of inflationary pressures. For example, if headline inflation is lower than core inflation, as it is as of this writing, then analysts might infer that recently declining food and energy prices have been restraining headline inflation. In addition, although central banks must ultimately control inflation from any cause, many models of the economy would suggest that supply induced inflation should elicit a different response than inflation due to expansionary fiscal or monetary policy.

Fed Chair Jerome Powell cited a specific category of inflation—inflation in core services other than housing—as being perhaps “the most important category for understanding the future evolution of core inflation.” The financial press has termed this category “supercore” inflation, and some analysts, such as Larry Summers, former Treasury secretary, have expressed concern that this measure of inflation remains too high.As an example of how this concept has permeated popular culture, see this YouTube video.

In summary, there are many measures of inflation that differ in how they weight price changes in categories of goods and services. Examining differences between these measures can shed light on some sources of inflationary pressures, although in the longer run, monetary policy can restrain aggregate demand to maintain price stability.

Notes

1. Other measures of inflation—median or trimmed means—use statistical procedures to exclude particularly volatile prices, not prices that have a history of past volatility. The New York Fed’s Applied Macroeconomics and Econometrics Center constructs a measure of core-trend inflation with sophisticated statistical techniques that seek to model the persistent component of inflation.
2. As an example of how this concept has permeated popular culture, see this YouTube video.