The consumer price index (CPI) covers a broad range of goods and services and provides a good general overview of the prices households are paying for things they typically buy. But because the CPI includes items whose prices rise and fall frequently, such as food and energy, the CPI is less good at measuring the underlying rate of inflation, or the rate of inflation that is likely to persist over medium-run horizons of several years.
A number of measures have been developed to measure underlying inflation. The CPI excluding food and energy prices (core CPI) removes price changes of the same items from the CPI each month, food and energy, because they are typically the most volatile. The median CPI and the trimmed-mean CPI use a different approach. These measures exclude whatever items change the most in price during the month, so the items that are eliminated from the CPI change from month to month. The median CPI excludes all price changes except for the one in the center of the distribution of price changes. The 16 percent trimmed-mean CPI excludes prices changes in the upper and lower tails of the distribution.
According to research from the Cleveland Fed, the median CPI provides a better signal of the inflation trend than either the all-items CPI or the CPI excluding food and energy. The median CPI is even better at forecasting PCE inflation in the near and longer term than the core PCE.
To calculate the median CPI, the Federal Reserve Bank of Cleveland looks at the prices of the goods and services published by the Bureau of Labor Statistics (BLS). But instead of calculating a weighted average of all of the prices, as the BLS does, the Cleveland Fed ranks the inflation rates of the components of the CPI and picks the one in the middle of the weighted distribution—that is, the 50th percentile, or the median inflation rate. The Cleveland Fed also calculates the 16 percent trimmed-mean CPI by taking the weighted average across the component inflation rates after excluding, or trimming, the top 8 percent and bottom 8 percent of the weighted distribution.
The method used to calculate the median CPI and the 16 percent trimmed-mean CPI was revised in September 2007 to correct for the potential distortion that the owners’ equivalent rent (OER) component could cause to the measures. For more detail, see this document.