Krugman on Core Inflation

Core inflation is one of those topics that people love to get angry about. I recently had a post mentioning that core inflation had its first substantial fall since 1982. When this was picked up by Seeking Alpha, several commentors wrote to say that of course prices are rising as anyone in the real world can plainly see.
Paul Krugman writes that this misses the point of what core inflation tells us:

First, let me clear up a couple of misconceptions. Core inflation is not used for things like calculating cost-of-living adjustments for Social Security; those use the regular CPI.
And people who say things like “That’s a stupid concept — people have to spend money on food and gas, so they should be in your inflation measures” are missing the point. Core inflation isn’t supposed to measure the cost of living, it’s supposed to measure something else: inflation inertia.
Think about it this way. Some prices in the economy fluctuate all the time in the face of supply and demand; food and fuel are the obvious examples. Many prices, however, don’t fluctuate this way — they’re set by oligopolistic firms, or negotiated in long-term contracts, so they’re only revised at intervals ranging from months to years. Many wages are set the same way.

Posted by on February 26th, 2010 at 10:09 am

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