Kristie M. Engemann

Michael T. Owyang

English

Research Papers in Economics

February 2005 MonetaryTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
O
ne of the more popularly cited indicators of econ-
omic welfare is the so-called core inflation rate.
It is often considered a better measure of trend
movements in aggregate prices than the overall inflation
rate because it tries to eliminate high-frequency fluctua-
tions. Low-frequency price changes are those that largely
stem from sustained monetary policy actions and, hence,
are more relevant to policymakers trying to gauge trend
inflation. While news reports might lead one to believe
that there exists a precise measure of the core inflation
rate, there is, in fact, no universally accepted definition.
In particular, two measures, shown in the accompanying
figure with consumer price index (CPI) inflation, are widely
used: inflation excluding food and energy (XFE) and
weighted median inflation (WMI).1
The most frequently reported measure of core inflation
is CPI inflation XFE. The overall CPI is a measure of the
total price that consumers pay for a given market basket
of goods and services compared with the base year, and
the inflation rate is the percentage change in the CPI from
a year earlier.2 CPI inflation XFE is calculated as the
rate of change in the CPI after food and energy are elimi-
nated from the market basket. Food and energy prices are
excluded because they can be highly volatile and difficult
to predict.
Popular in academic research, the WMI rate is a second
common measure of core inflation. In determining the CPI,
each component has an associated weight—the respective
proportion of all expenditures that consumers spend on
that particular item. The WMI rate is determined by com-
puting the simple monthly rate of change in prices for each
component, then ordering the items by their inflation rates,
and pairing each with its appropriate weight. WMI is the
inflation rate associated with an accumulated weight of
50 percent: In other words, for any month, half of the
components have inflation rates higher than the weighted
median, while the other half have lower inflation rates. This
is an appealing measure of core inflation because it elim-
inates components with relatively large (and relatively
small) changes in prices, which generally do not persist,
while the weighted median more closely reflects the per-
sistent trend in price movements.3
Smith (2004) analyzes various measures of core infla-
tion—including the two described here—in an attempt to
determine the optimal choice.4 She defines core inflation
as the best predictor of future inflation, and her tests provide
evidence that, of the two, WMI does indeed do a superior
job at predicting future inflation, which other economists
have also shown. Inflation XFE excludes the same compo-
nents in every period, even if their individual price fluctua-
tions are not unusual relative to those of other components,
whereas the WMI eliminates different components each
month, depending on their price fluctuations at that time.
Consequently, the latter appears to be a better method to
capture the underlying price trend among all expenditures.
Therefore, the core inflation rate that we typically read about
in the newspaper might not be the one that best forecasts
future inflation. 
—Kristie M. Engemann and Michael T. Owyang
1 Alternative measures of core inflation exist—e.g., the trimmed mean. The per-
sonal consumption expenditures price index is sometimes used instead of the CPI
and is preferred by policymakers.
2 The Bureau of Labor Statistics lists the following major groups in the CPI mar-
ket basket: food and beverages; housing; apparel; transportation; medical care;
recreation; education and communication; and other goods and services.
3 Clark, Todd E. “Comparing Measures of Core Inflation.” Federal Reserve Bank
of Kansas City Economic Review, Second Quarter 2001, 86(2), pp. 5-31.
4 Smith, Julie K. “Weighted Median Inflation: Is This Core Inflation?” Journal of
Money, Credit, and Banking, April 2004, 36(2), pp. 253-63.
CPI Inflation Rates (Seasonally Adjusted)
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
Jan 84
Jan 86
Jan 88
Jan 90
Jan 92
Jan 94
Jan 96
Jan 98
Jan 00
Jan 02
Jan 04
Year-Over-Year % Change
Inflation
Inflation Excl. Food and Energy
Weighted Median Inflation
SOURCE: Bureau of Labor Statistics and the Federal Reserve Bank 
of Cleveland.
Hard “Core” Inflation
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Hard 'core' inflation

http://research.stlouisfed.org/publications/mt/20050201/cover.pdf

Hard 'core' inflation

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