Why do central banks like the Bangko Sentral ng Pilipinas (BSP) prefer to use core inflation instead of headline inflation when making monetary policy decisions?
Answer (1)
Central banks like the Bangko Sentral ng Pilipinas (BSP) prefer using core inflation instead of headline inflation because core inflation gives a clearer and more stable view of long-term price trends in the economy. Core inflation removes the prices of food and energy from the inflation calculation because these items tend to be very volatile. In countries like the Philippines, prices of rice, vegetables, and fuel can change quickly due to typhoons, global oil prices, or supply disruptions. These short-term changes can make headline inflation appear very high or very low even if the rest of the economy is stable.For example, during typhoon season in the Philippines, floods may destroy crops in Central Luzon or Bicol. This would cause rice and vegetable prices to go up rapidly, affecting headline inflation. However, this kind of price increase is temporary. BSP knows that if they raised interest rates every time food prices spike due to a storm, it might hurt the economy unnecessarily. By focusing on core inflation, which excludes these unstable prices, the BSP can make more balanced and long-term decisions.Core inflation reflects the underlying trend in prices—how much the overall cost of living is changing without being distracted by sudden shocks. This helps the BSP decide whether to raise or lower interest rates. If core inflation is rising steadily, it may be a sign that the economy is overheating and needs cooling down. If core inflation is low or falling, it could mean that demand is weak, and people are not spending enough, which may lead the BSP to lower interest rates to stimulate economic activity.In summary, core inflation provides a more accurate measure of real price trends. It helps avoid overreacting to short-term price movements and supports better long-term planning and monetary policy.
