Why do central banks use core inflation instead of headline inflation for setting policy?
A. Core inflation is easier to understand
B. Headline inflation includes irrelevant data
C. Core inflation removes volatile prices and gives a better long-term trend
D. Headline inflation is always higher
Answer (2)
The correct answer is C. Core inflation removes volatile prices and gives a better long-term trend.Central banks focus on core inflation because it excludes volatile items like food and energy prices, which can fluctuate sharply due to temporary factors (e.g., weather, supply shocks). By removing these, core inflation provides a clearer view of the underlying, persistent inflation trend, helping policymakers make better decisions for the long term. Headline inflation, on the other hand, can be misleading in the short run because of these temporary swings.
The correct answer is letter C. Core inflation removes volatile prices and gives a better long-term trendCentral banks like the Bangko Sentral ng Pilipinas (BSP) prefer core inflation because it gives a clearer picture of long-term inflation trends. Core inflation excludes prices of food and energy, which can change quickly due to weather, natural disasters, or global oil prices.For example, if a typhoon damages crops in the Philippines, food prices might spike temporarily. That would push up headline inflation—but it doesn’t mean the whole economy is overheating. By looking at core inflation, the central bank can avoid overreacting to short-term price changes and focus on the true, underlying inflation in the system.This helps them decide whether to raise or lower interest rates to control inflation, without being misled by short-lived price shocks.
