U.S. Inflation

Measuring Core Inflation

Q What is core inflation?

There is no generally agreed upon definition of core inflation. However, in the United States, core inflation has commonly come to be known as an inflation measure that excludes the prices of food and energy goods. Food and energy goods are the most volatile of the components used to compute the Consumer Price Index (CPI), and the behavior of these goods regularly causes fluctuations in the inflation measure that are not characteristic of the inflation statistic’s longer-term trend. Because of this, the CPI may be a misleading monthly signal of the inflation trend that economic policymakers wish to control.

However, the “ex-food and energy” approach does not address transitory price fluctuations in other components of the retail market basket used to construct the CPI. Further, such an approach may bias the inflation measure if there are long-term movements in food and energy prices relative to other goods and services.

An alternative approach to eliminating volatile price movements from the CPI is through the use of trimmed-mean estimators, which eliminate any price change above or below a certain threshold, regardless of what the component is. These measures provide a better signal of the inflation trend than either the all-items CPI or the CPI excluding food and energy.

Q What are “trimmed-mean” CPI inflation estimates? Why are they useful measures of inflation trends?

The CPI trimmed-mean estimators reported monthly by the Federal Reserve Bank of Cleveland exclude the components in the CPI that show the most extreme monthly price changes. Excluding 8 percent of the CPI components with the highest and lowest one-month price changes from each tail of the price-change distribution results in a “16 percent trimmed-mean” inflation estimate. In addition, we report a more substantial trim—49½ percent—from each tail to obtain the middle component’s price change, or median CPI. These measures are much less volatile than either the CPI or the more traditional core CPI, making them more useful guides in evaluating U.S. inflation trends.

Q Why have you changed the methodology of the trimmed-mean CPI estimators?

A potential problem of using trimmed-mean CPI estimators arises when one of the components in the inflation aggregate has an unusually large weight, such as the 24 percent weight given to the Owners’ Equivalent Rent (OER) component of the CPI. The influence of this component can grow disproportionately as the proportion of extreme changes trimmed from the data increases. Indeed, the influence of the OER component on the median CPI can be seen in Table 1, which documents that from January 1998 to July 2007, OER was the median component 64 percent of the time.

 

Table 1: Frequency at which a Component Has Been the Median Component, January 1998– July 2007

 

Component

Relative importance*

Percent

Prior

Revised

Cereals and bakery products

1.10

3.48

1.75

Meats, poultry, fish, and eggs

2.11

0.00

1.75

Dairy and related products

0.82

0.87

0.88

Fresh fruits and vegetables

0.96

0.00

0.00

Processed fruits and vegetables

0.25

0.00

0.00

Nonalcoholic beverages and materials

0.91

1.74

0.00

Other food at home

1.74

0.00

1.75

Food away from home

5.99

6.96

10.53

Alcoholic beverages

1.11

1.74

0.00

Rent of primary residence

5.93

6.09

5.26

Lodging away from home

2.65

0.87

0.00

Tenants’ and household insurance

0.37

0.00

0.00

Fuel oil and other fuels

0.34

0.00

0.00

Gas (piped) and electricity

4.03

0.00

0.00

Water, sewer, and trash collection

0.90

0.87

0.88

Household furnishings and operations

4.65

1.74

2.63

Men’s and boys’ apparel

0.89

0.00

0.00

Women’s and girls’ apparel

1.59

0.87

0.88

Footwear

0.75

0.00

0.00

Infants’ and toddlers’ apparel

0.18

0.00

0.00

Jewelry and watches

0.33

0.00

0.88

New vehicles

4.98

0.00

2.63

Used cars and trucks

1.72

0.00

0.00

Car and truck rental

0.09

0.00

0.00

Motor fuel

4.35

0.87

0.88

Motor vehicle parts and equipment

0.37

0.00

0.00

Motor vehicle maintenance and repair

1.15

0.00

2.63

Motor vehicle insurance

2.26

0.00

1.75

Motor vehicle fees

0.48

0.00

0.88

Public transportation

1.06

0.00

0.00

Medical care commodities

1.45

0.87

0.88

Medical care services

4.83

5.22

1.75

Recreation

5.55

1.74

7.02

Education

3.08

0.00

0.00

Communication

2.96

0.00

0.00

Tobacco and smoking products

0.71

0.00

0.00

Personal care products

0.71

0.00

0.00

Personal care services

0.68

0.87

1.75

Miscellaneous personal services

1.19

2.61

0.88

Miscellaneous personal goods

0.19

0.00

0.00

Leased cars and trucks

0.60

0.00

0.00

Owners’ equivalent rent of primary residence

23.83

64.35

51.75

OER, Northeast Urban Region

5.55

NA

11.40

OER, Midwest Urban Region

4.83

NA

8.77

OER, South Urban Region

7.23

NA

20.18

OER, West Urban Region

6.22

NA

11.40

*Relative importance value from December 2006.

The Federal Reserve Bank of Cleveland is reducing the influence of the OER component on the computation of the trimmed-mean (and median) CPI statistics by breaking OER into four regional subindexes. This should improve the ability of the trimmed-mean measures to gauge the CPI trend, especially as greater percentages of the extreme components of the CPI are trimmed from the data. In fact, when examined over the time period from January 1998 to July 2007, this revised methodology reduces the proportion of times an OER component is the median component from 64 percent to 52 percent (see Table 1) .

Q How do estimates of the underlying inflation trend using this new methodology compare with estimates using the original methodology?

The influence of the new methodology on the 16 percent trimmed-mean CPI is very small. In July 2007, for example, the 16 percent trimmed mean was 1.8 percent (annualized) using both the new and previous methodology, and historically these two approaches yield very similar readings. (See Table 2.) The old and revised median CPI were very similar in July 2007 as well, rising 2.0 percent (annualized) and 2.1 percent (annualized), respectively. However, the influence of the new methodology on the computation of the median CPI can be significant. For example, using the original methodology, the increase in the median CPI in May 2007 was 1.0 percent (annualized). Using the new methodology results in an increase in the median CPI for May 2007 of 2.4 percent (annualized).

Table 2. 2007 Annualized Monthly Percent Change of Original and Revised Trimmed-Mean CPI Measures

 

 
February
March
April
May
June
July
Revised median CPI
4.2
3.0
2.7
2.4
2.6
2.1
Original median CPI
3.6
3.3
2.1
1.0
2.5
2.0
Revised 16% trimmed-mean CPI
3.6
3.3
2.5
2.2
2.1
1.8
Original 16% trimmed-mean CPI
3.6
3.2
2.5
2.3
2.1
1.8

 

Q How can I obtain the revised median CPI and 16 percent trimmed-mean CPI data?

Beginning in September 2007, the median CPI and 16 percent trimmed-mean CPI reported by the Bank will be constructed using the new methodology. The data are available monthly, via e-mail and on the Bank’s website, on the morning the Bureau of Labor Statistics releases its Consumer Price Index.

To receive the trimmed-mean data monthly via e-mail, contact Joel Elvery at the Cleveland Reserve Bank at joel.elvery@clev.frb.org or visit the Bank’s website at:

http://clevelandfed.org/research/inflation/US-Inflation/mcpi.cfm.

Note: Monthly estimates using the original methodology will no longer be computed. Historical data for the revised series are available back to January 1983, and the original series is available from February 1967 to July 2007 on the Bank’s website at:

http://clevelandfed.org/research/inflation/US-Inflation/mcpi.cfm.