INFLATION

What is core inflation?

It refers to changes in the price of a select basket of commodities, which excludes items with volatile prices such a food and fuel.

Why do central banks follow core inflation more closely than headline inflation?

To manage the rate of price rise, central banks need to know the underlying demand pressures in the economy, as heavy demand tends to push prices up.

Core inflation provides this measure. It gives an indication whether manufacturers are able to pass on any rise in input costs without suffering a drop in demand. Thus, core inflation helps central banks predict headline inflation.

Does core inflation influence monetary policy?

High core inflation indicates demand pressures in the economy that can trigger rapid price rise. A central bank can then lift interest rates to dampen demand and lower inflation. On the other hand, if core inflation is low, the central bank can cut rates to spur demand.

If a central bank focuses only on headline inflation, which could be rising because of high food prices, then its monetary signals will fail to yield the desired benefits because demand for food is not much influenced by interest rates. In such a situation, monetary policy could hit elsewhere, for instance, investments.

How is core inflation measured in India?

India got a nationwide measure of retail inflation only last year. Given the lack of historical data, the wholesale price index is still the most widely watched measure of prices.

It includes three broad categories of items - primary articles (which include food), fuel and manufactured goods. While some economists consider inflation in manufactured goods as a measure of core inflation, other slice it further to consider only the non-food manufactured goods.