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Core inflation Calculation

  • Category
    Economy
  • Published
    14th Apr, 2023

Context

RBI former secretary has highlighted that country’s Core Inflation calculation excludes food price (as they are volatile), which needs a particular observation due to increasing significance in recent times.

S&P Global Ratings recently said core inflation in India has been declining sequentially, and an elevated 6.25 percent policy rate limits the need for further rate hikes.

What is Core Inflation?

  • Core inflation is the change in the costs of goods and services but does not include those from the food and energy sectors.
  • Food and energy prices are exempt from this calculation because their prices can be too volatile or fluctuate wildly.

Why is it important?

  • Core inflation is used to determine the impact of rising prices on consumer income.
  • If the increase in the price index is due to temporary shocks that could soon reverse themselves, it may not require any monetary policy action.
  • To deal with such situations, many central banks use measures of core inflation that are designed to filter the transitory price movements.
  • Core inflation by eliminating the volatile components from the headline helps in identifying the underlying trend in headline inflation and is believed to predict future inflation better.
  • Core inflation is a convenient guide to help the central bank achieve its objective of controlling total inflation.

What is Headline Inflation?

  • It is the raw inflation figure reported through the Consumer Price Index (CPI).
  • The CPI determines inflation by calculating the prices of a fixed basket of goods.
  • Core inflation removes the CPI components that can exhibit large amounts of volatility from month to month.

Why is it important to consider Food inflation?

  • In India, food prices have only risen, and in recent years their rate of inflation has been very high.
  • For all the ‘reforms’ since 1991, the real price of food, i.e., its price relative to the general price level, has risen considerably.
  • In the context, to measure inflation without considering the price of food is to exclude what matters most to the public, as opposed to central bankers. India’s inflation control strategy is currently restricted to using the interest rate to dampen aggregate demand.

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