On the Methodology of Measuring Core Inflation

Abstract

We propose a new methodology to construct core inflation which is, unlike other conventional methods, not based on ad hoc elimination/trimming of prices. The empirical results suggest that the proposed measure of core inflation is highly correlated with headline inflation and is noise free; hence less volatile. The underlying inflation derived from such method is found to be a powerful leading indicator of headline inflation while other conventional measures do not seem to reflect such fundamental property of core inflation.

A Study on the Dynamic Behaviour of Headline Versus Core Inflation: Evidence from India

“…Similar approaches were incorporated in the study by Kar (2009) and Raj and Mishra (2011), where they suggested that core inflation could be used as an operational guide for monetary policy in the short term. Furthermore, Sharma and Bicchal (2015), Rather, Durai and Ramachandran (2016) and Sahu and Sharma (2018) have also built core inflation through trimmed mean approach for India.…”

“…In India, headline inflation is considered as a targeted variable for determining key policy rates, yet it is often claimed in literature (Bryan & Cecchetti, 1994;Clark, 2001;Cogley, 2002;Crone et al, 2013;Detmeister, 2011;Kiley, 2008;Liu & Smith, 2014;Mehra & Reilly, 2009;Mishkin, 2007;Rich & Steindel, 2005;Rather et al, 2016;Sharma & Bicchal, 2015;Smith, 2005;Wynne, 1999;2008) that the underlying trend of headline inflation called core inflation, which removes most volatile components from overall inflation, is likely to be the best choice for monetary policy decision making.…”