Core inflation, what is it? To be fair, most people can’t answer that question. Many, however, would be surprised to learn that it does not include the prices of food and energy.
Why then does the U.S. government track "core inflation?" Or perhaps a better question is, why are food and energy left out of it?
Core inflation is a measure of inflation that excludes certain items known for their volatility. Food and energy are well-known for their volatile pricing nature, since they are subject to outside influences not always tied to inflation.
For instance, an untimely frost in Florida might damage the citrus crops in the state. This could lead to a spike in the cost of orange juice, and that has nothing to do with inflation in general. It is merely a fact of nature.
Similarly, an embargo might be placed on an oil-producing country. This then, could strain the supply of oil and lead to increased costs for energy products like gasoline. While detrimental to the pocket-books of drivers, these price increases would be a result of political sanctions and not of general inflation.
By eliminating food and energy from the equation, economists can get a better understanding of the longer run trend in prices of goods and services, and resultantly better identify inflation trends for the longer haul.
Core inflation is closely watched by the Fed, specifically the Federal Open Market Committee (FOMC), as it helps the central bank decide where to set the benchmark interest rate. The FOMC has a target core annual inflation rate of 2%.
With all this said, do not be under the impression that food and energy costs are discarded entirely from economic equations and the inflation landscape. While important to economists and the Fed, core inflation is just one of many inflationary components that are monitored. In reality, the Labor Department’s Bureau of Labor Statistics tracks the pricing trends of about 10,000 different items, like fuel oil and gasoline, fruits and vegetables, transportation, clothing, vehicles, healthcare, homes and furniture. Accumulated data is published monthly and is used to calculate what we commonly refer to as the overall inflation rate. By tracking thousands of different items, the economists can more accurately see what the average consumer is spending and where prices are headed.