In day to day news papers we have the news regarding inflation .If we dig deeper ,we need to understand the Headline inflation and core inflation.
So, in day to day news,what we hear is Headline Inflation, while RBI focuses on Core inflation to device policies.
Headline Inflation:
- Headline inflation is a measure of the total inflation within an economy.
- This inflation including commodities such as food and energy prices.
- Headline inflation is the raw inflation figure.
- It can be either Wholesale price index (WPI) or Consumer Price Index.
CORE INFLATION / UNDERLYING INFLATION:
- It is a measure of inflation which excludes items having volatility in price movement, notably food and fuel.
- Core Inflation is nothing but Headline Inflation minus food and fuel inflation.
Understand dynamics of Core Inflation:
- Food and fuel prices are subjected to fluctuations very frequently, even this frequency may be on a daily basis.
- Prices of other commodities, do not fluctuate as regularly as food and fuel
- Increase in the prices of other commodity except food and fuel are relatively much more of a permanent nature.
Because of the abovementioned reason:
- It is clear that if central bank targets Headline inflation then that policy will not be appropriate to check the inflation as headline inflation also takes into account changes in the price of food and energy which is of volatile nature .
- Since food and energy prices are highly volatile, headline inflation may not give an accurate picture of how an economy is behaving. Responding to headline inflation might therefore sometimes be inappropriate as it is subjected to frequent variability.
- In Indian context, demand is not the only factor that causes inflation, there are supply side factors as well.
- Food and fuel prices are caused by temporary supply shocks and international factors that affect the prices of food and fuel. These factors are out of control of RBI as these factors are out of bound for RBI and are considered temporary and volatile in nature.
Logically Central Banks need to target only core inflation, as it reflects the demand side pressure in the economy. In practice too, the Reserve Bank of India (RBI) and Central Banks around the World always keep an eye on the core inflation. Whenever core inflation rises, Central Banks increase their key policy rates to suck excess liquidity from the market and vice versa.
Conclusively, core inflation acts as an index that can serve you better
in gauging the effect of monetary policy on inflation rates by removing the
components that are volatile in nature and are more prone to price rises due to
supply side shocks.
