Inflation is the rate of change in price levels. It’s a broad measure used to convey the increase in cost of living in a particular nation or its provinces/states.
Core inflation is separate from headline or overall inflation. This metric is a gauge of the change in the costs of goods and services, excluding the effects of food and energy prices.
Food and energy prices change so quickly and by such magnitudes that their inclusion can unduly affect headline numbers. Food and energy prices are more volatile because they are heavily traded items on the commodities market.
Core inflation metrics are thought to give a more accurate picture of long-term inflation and are the preferred indicator for central bankers, who pay them more heed when deciding on policy moves.
Monetary policy is set with a long-term view so it makes sense to exclude transitory price changes and focus on long-run inflation. This is accomplished by excluding items subject to price volatility, like food and energy.
If the core inflation rate becomes too high, central banks typically respond with an increase in short-term interest rates, which means higher rates on mortgages, credit cards, and other consumer and business loans.
When the core inflation rate is elevated, consumer goods like housing, transportation, and clothing will be more expensive, and so too will the cost to borrow money that might be needed to purchase necessary items.
Interestingly, inflation targeting is a somewhat recent phenomenon and The Bank of Canada along with many other central banks, state their inflation targets in terms of headline or total inflation, and not core inflation.
FUN FACT: Canada was the second country to implement inflation targeting (in 1991) after New Zealand did it first (in 1990).
