Consumer prices: headline, core and base effects

What the index measures

The Consumer Price Index Manual, published in 2020 by the IMF, the ILO, Eurostat, the OECD, the UN Economic Commission for Europe and the World Bank, describes consumer price indices as measures of changes over time in the general level of prices of goods and services that households acquire. In practice the index follows the cost of a fixed-weight basket of goods and services.

Each item counts according to its weight, its share of household spending. The Manual names household budget surveys as one of the main sources of weights and says that, at a minimum, weights should be updated every five years. Practice varies by market: in the Philippines, the statistics authority bases the weights on its Family Income and Expenditure Survey, keeps them fixed until the index is rebased, and rebases the index every six years.

From the index to the inflation rate

The index is set to 100 in a base period. The inflation rate that is usually reported is the change in the index over twelve months, which the Philippine Statistics Authority defines as the year-on-year change of the index expressed in percent.

Year-on-year inflation, in percent = (index this month ÷ index in the same month a year earlier − 1) × 100

Worked example, with illustrative numbers: if the index is 112.2 this month and was 108.0 in the same month last year, inflation is 112.2 divided by 108.0, minus 1, times 100, which is about 3.9%. The month-on-month change compares this month with last month instead; it reacts faster but is noisier, because of seasonal patterns in food and other prices.

Headline and core

Headline inflation covers every item in the basket. Core inflation leaves out items whose prices swing sharply, so that the underlying trend is easier to see. Each market draws the line in its own way.

• Philippines. The statistics authority's core index excludes volatile items such as cereals, some meats, fish, fresh produce, electricity and fuels.
• Indonesia. Bank Indonesia separates core inflation, which it calls the persistent component, from volatile food and from administered prices, which are driven mainly by government price policy on items such as subsidised fuel, electricity rates and transport fares. Statistics Indonesia calculates the index.
• Thailand. The Bank of Thailand breaks headline inflation into raw food, with a weight of about 17%, energy, about 13%, and core inflation, about 70%. Its monetary policy target is set in terms of headline inflation, within a range of 1 to 3%.

Both measures matter to a lender. Headline inflation is what households actually pay for. Core inflation helps to read the underlying trend in prices, which central banks watch when setting policy rates.

Base effects

Because the usual rate compares with the same month a year earlier, last year's prices matter as much as this year's. The European Central Bank describes a base effect as the effect on the year-on-year inflation rate when an unusually large month-on-month change twelve months earlier drops out of the comparison.

Worked example, with illustrative numbers: the index stood at 100 until a fuel price increase lifted it to 105 in March last year, and it has stayed at 105 since. In February this year, inflation is 105 against 100, or 5%. In March this year, with no price changing, inflation is 105 against 105, or zero. The rate fell by five points because last year's jump dropped out, not because anything became cheaper.

Reading the numbers as a lender

• Look at the level, not only the rate. When inflation falls back, prices have stopped rising faster; they have not come down. A household's budget carries the whole increase since its income was last adjusted.
• Check for base effects before reacting. A sudden rise or fall in the rate may come from last year's prices.
• Use the right measure for the question. Headline for household costs, core for the direction of policy rates.
• Compare like with like. Core measures differ by market, so compare markets on headline inflation unless the definitions match.
• Remember whose basket it is. The index reflects average spending, and a lower-income household's spending can be made up differently; lesson 2 covers this.