A Comparison of Measures of Core Inflation

entral banks differ in their specific inflation objectives and conduct of policy. However, they typically confront the common problem of identifying which price changes are permanent and which are transitory. Because of the lagged effects of monetary policy, mistaking the nature of price changes can be extremely costly. For example, the failure to detect the onset of inflationary pressures may lead to a sustained rise in inflation and ultimately require a more prolonged period of policy tightening. Then again, an overreaction to a temporary increase in inflation may result in an unwarranted slowing, and possible decline, in economic activity. Thus, the ability of central banks to differentiate between permanent and transitory price movements is critical for determining the appropriate prescription for monetary policy. The importance of gauging the persistence of price changes in a timely manner has led to the development of schemes to filter incoming data on aggregate prices. The filtering schemes are designed to remove transitory price movements and thereby produce a measure of underlying, or “core,” inflation. The most common measure of core inflation is aggregate household inflation excluding the contribution of price