What is the utility of core inflation?
Let’s first understand the Headline Inflation. Headline Inflation includes all the items of the basket & no item is excluded in calculation of increased prices.
In calculation of Core Inflation, certain commodities are excluded.
Why should we exclude?
Headline Inflation includes some highly volatile commodities whose prices may rise in the short-term. Like the prices of Fuel & Food. The price of Fuel may rise due to increase in the price of global fuel price. The price of Food might rise due to less monsoon, more rainfall, calamities, etc. But these “supply shocks” or fluctuations on the Supply-side are temporary/short-term.
So, to factor out the “fluctuations”, we exclude certain volatile components like Food & Fuel in the calculation of inflation. This is called Core Inflation or Underlying Inflation.
Core inflation measures the TREND INFLATION i. e. long-term trend in the general price level (*as the short-term fluctuations have been factored out in the calculation).
Core inflation is indicative of the demand-driven inflation.
And since, the Central Banks respond to demand in the market; the core inflation helps them in policy formulation (Monetary Policy).
With Great Love,
Er. Amit Yadav