Core Inflation in the United States How it is Calculated and Its Important Role
The core inflation rate in the United States is food and energy minus the price change for goods and services. The prices of food and energy products are volatile; they change so rapidly now that the inclusion of these categories gives an accurate idea of the true severity of inflation.
The core CPI is the core inflation rate in the United States, and the consumer price index (CPI) is synonymous with low food and energy prices. This exclusion makes the headline inflation rate more accurate than the headline inflation rate in measuring underlying inflationary trends. This is why central banks quite often prefer to use the core inflation rate when setting monetary policy.
By the Numbers
- The core inflation rate (all commodities except food and energy) increased by 6.6% year-on-year since September 2021.
- The core inflation rate in the United States increased to 0.6% in September 2022.
- The core CPI in the United States reached its highest rate since 1982.
What does core inflation mean to you as an ordinary citizen?
So regular inflation—the growth of all commodities, including food and energy products—can certainly impact the everyday life of the common citizen, forcing you to tighten your budget earlier, according to the Federal Reserve. Core inflation is the preferred indicator of inflation. This simply means that, if the core inflation rate becomes higher than before (and remains so), the Federal Reserve System’s board of governors will raise the federal funds rate, which directly impacts the common citizen, raising interest rates on mortgages, credit cards, and other consumer lending products.
In other words, whenever the core inflation rate rises in the future, not only will consumer goods such as housing, transportation, and clothing become more expensive, but the cost of borrowing money to buy those goods will also become more expensive.
Why are food and energy prices volatile in the United States
Food and energy prices in the United States are volatile because food and energy are traded in the commodity market. Most foods (such as wheat, pork, and beef) and energy (oil, gas, and natural gas) are traded in commodity markets throughout the day.
For example, commodity traders in the commodity market bid up the price of oil if they suspect its supply will fall or demand will increase. They may think that the war will deplete the supply of oil. In the commodity market, they will buy oil at today’s price to sell at tomorrow’s highly anticipated price. This is enough to drive up oil prices. If the war doesn’t happen, oil prices fall when traders sell in the commodity market.
Note: Prices for food and energy change rapidly in response to human emotions rather than slowly changing supply and demand.
Whenever there is an increase in gas prices as well as food prices, food is transported by interstate trucking. It consumes a lot of gas. Whenever gas prices rise and remain high, you will eventually see a direct impact on food prices in a matter of weeks.
How the Fed Uses the Core Inflation Rate
The mandate of the Fed is to control inflation. While the Fed’s preferred measure of inflation is the Personal Consumption Expenditure (PCE) price index, the Fed also frequently looks at the core inflation rate.
Note: Fed tools take time to work. It may also take several months before a change in the fed funds rate affects prices.
How does the fed funds rate affect inflation? If the fed funds rate rises, the rate on bank loans and adjustable-rate mortgages will also increase. So, as credit strengthens, economic growth slows. As a result, companies must lower their prices to remain in business, and this reduces inflation.
The Fed targets the inflation rate. If the core inflation rate is 2% lower than the previous year, it will not function as it would like to remain in place.
What happens if the core inflation rate starts rising and inflation starts to creep above the target and then maintains that level? The Fed is looking to tighten monetary policy and hike interest rates. The Fed must balance this with its other goal of spurring job growth and economic expansion.
On June 15, 2022, the Federal Open Market Committee (FOMC) announced that it would raise interest rates for the third time this year to combat rising inflation. So the target range was raised by 75 basis points, from 0.75% to 1% and from 1.50% to 1.75%.
The chart below shows the United States’ core inflation rate from 1958 to the present. Notably, this is the year-over-year rate for each month. So it measures how much prices, excluding food and energy, have changed each month over a 12-month period.
United States Annual Core Inflation Rate Less Food and Energy
The core inflation rate is the percentage change from year to year of the price of a basket of all goods and services, except food and energy. The gray shaded areas represent the recessions.
Chart: Fox Us Usa Get the Data
How is the Core Inflation Rate Calculated?
The core Consumer Price Index (CPI) and the core Personal Consumption Expenditures (PCE) price index are used to calculate the core inflation rate. At the FOMC meeting in January 2012, the Federal Reserve said that it preferred to utilize the PCE price index.
The CPI is released by the Bureau of Labor Statistics (BLS), which compiles labor statistics. For the purpose of calculating the index, it examines the prices of 80,000 consumer products. The result is that it gathers this pricing data from thousands of retail and service businesses. Additionally, a sample of 14,500 families was chosen, along with the kinds of companies they patronize.
This requires a lot of mathematical calculations, as you might expect, but it provides an accurate picture of price fluctuations. Unlike the PCE price index, it is less inclusive.
Note: Both the Bureau of Economic Analysis (BEA) and the BLS reduce the prices of any sold food and energy products to calculate the core inflation rate.
Compared to the core CPI, the PCE price index provides a more accurate summary of underlying inflation rates. As a result of the method it is measured, it is less volatile.
The PCE pricing index is published by the BEA. Using the information on the gross domestic product (GDP), the bureau calculates price changes. The monthly Retail Survey results are then included and adjusted for consumer prices using the CPI. The BEA smooths out any data differences by computing its estimates using a separate PCE formula.
Why the Core Rate Is Critical
When the costs of the products and services you purchase keep rising over time, this is called inflation. You lose purchasing power as prices grow if your income doesn’t increase at the same amount. Only when inflation affects your income does it not lower your level of living.
Note: When the prices of anything like your home or your stock portfolio go up, inflation benefits you. Hence it is also known as asset inflation.
Inflation often has a subtle but devastating effect on economic growth. So it’s subtle because you might even notice it over time if it’s only a 1% or 2% increase. If at that rate, it might have a slightly positive effect. Most economists believe that consumers will stock up on goods now because they know their prices will increase in the future. And this also increases demand, which accelerates economic growth in the future.
Over time, the economy loses the capacity for growth due to high inflation. If your wages don’t increase, people are forced to spend more of their income on essential items like food and gas and less on other consumer products. Some of those other businesses will become less profitable, and some will close over time. And most of all, it can reduce the economic output of the country.
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