Among the most highly anticipated economic indicators released each month is the consumer price index (CPI), which measures the prices paid by urban consumers for a representative basket of goods and services.1 As discussed in Blinder and Reis (2005), one of the innovations of the Greenspan era was a shift in focus for monetary policymakers and the markets from so-called headline, or total, inflation to so-called core inflation, which excludes the food and energy components. One rationale for using core inflation rather than total inflation as a guide to the underlying inflation rate is that the food and energy components tend to be more volatile from month to month than other components. To the extent that movements in these components are not lasting, including them yields a noisier signal about the underlying inflation rate to which monetary policymakers should be attuned.2 Another, related rationale is that core inflation may be a better predictor of total inflation and, therefore, a better guide for monetary policymakers, who, given the lags in monetary policy’s effect on the economy, need to be forward looking when setting policy.
In this note, we provide some evidence about the two rationales. First, we examine the volatilities of the food and energy components of inflation relative to the volatilities of core and total inflation. Second, we extend and update the analysis of Blinder and Reis (2005), which indicates that current core inflation is a better predictor of future total inflation than is current total inflation itself. In particular, Blinder and Reis’s sample ends in March 2005, and we update it through December 2005. We also examine the performance of additional measures of inflation in forecasting future total inflation, including CPI inflation less energy, monthly personal consumption expenditures (PCE) inflation, monthly core PCE inflation, the Federal Reserve Bank of Cleveland’s weighted median CPI, and the Federal Reserve Bank of Dallas’s trimmed-mean PCE. Our work is related to a large literature that investigates the prediction of total inflation by core inflation. Cogley (2002) discusses the rationales behind various measures of core inflation and proposes and evaluates several as predictors of medium-run inflation. See also Rich and Steindel (2005), Clark (2001), and Smith (2004) for recent studies and reviews of the literature.