Measuring Inflation

(co-authored with my colleague Sam Waters)

Inflation or indeed its opposite has driven monetary policy among the largest high income economies. With nominal rates thought to be bounded by zero, the US, UK, and Japan engaged in operations to increase the size of the central bank’s balance sheets as an unorthodox channel of easing monetary conditions. European central banks demonstrated interest rates can fall below zero.

Countries have adopted different measures of consumer inflation. Few discussions seem to be informed by this fact that makes international comparisons of inflation more difficult. What we offer here is a brief comparative analysis of the headline and core inflation measures used by the US, UK, Japan, and the Eurozone.

Price stability is a mandate shared by nearly all central banks. Often central banks themselves choose precisely how this should be operationalized. The Federal Reserve and the Bank of Japan have adopted core inflation targets while the ECB and the Bank of England focus on the headline rate.

The logic of focusing on the core rate is that it is where price signals emanate. Food and energy tend to be volatile, and, therefore, obscure the signal with noise. Over the last half century in the US, headline inflation converges with core inflation, and not the other way around. In fact, a recent San Francisco Federal Reserve paper found that this year’s core inflation is a better predictor of next year’s headline inflation than the break-evens (the yield of a conventional Treasury bond minus yield of an inflation-linked security with the same maturity). Also, food and energy are often driven by supply considerations, which is something that monetary officials tend to have somewhat less influence over than demand.

Core CPI: Components / Relative Importance

Core CPI

Components

Total Index Weight

Eurozone

All items less food, energy, alcohol, tobacco

69.73

Japan

All items less fresh food

96.04

All items less food, energy, alcohol, tobacco

77.60