Measuring U.S. Core Inflation: The Stress Test of COVID-19

IMF Working Papers, December 17, 2021

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Large price changes in industries affected by the COVID-19 pandemic caused erratic fluctuations in the U.S. headline inflation rate during 2020-2021.
The Federal Reserve’s preferred core measure, the inflation rate excluding food and energy prices (XFE), performed poorly: over most of 2020-21, XFE was almost as volatile as headline inflation.
Core measures that exclude a fixed set of additional industries (for example, the Atlanta Fed’s sticky-price inflation rate) were less volatile than XFE.
The least volatile core measures were those that filter out large price changes in any industry, notably:
- the Cleveland Fed’s median inflation rate, and
- the Dallas Fed’s trimmed mean inflation rate.
These filtered core measures followed smooth paths: drifting down when the economy was weak in 2020 and then rising as the economy rebounded.
Overall conclusion: the case for the Federal Reserve to move away from the traditional XFE measure of core strengthened during 2020-21.

Comparison focused on alternative approaches to filtering out transitory effects of large industry-specific price changes and measuring the underlying or core level of inflation over 2020-2021.
Approaches compared included:
- XFE (inflation excluding food and energy prices);
- fixed-set exclusions (e.g., Atlanta Fed’s sticky-price inflation rate);
- filtering out large price changes in any industry (e.g., Cleveland Fed median, Dallas Fed trimmed mean).

Measures that dynamically filter out large industry price changes provide smoother, more stable signals of underlying inflation during episodic shocks like COVID-19.
Relying on XFE during 2020-21 could have led to misleading assessments of underlying inflation dynamics because XFE mirrored headline volatility.
Policymakers and central banks may obtain more reliable short-term core inflation signals by incorporating median or trimmed-mean style filters rather than fixed-exclusion XFE alone.
The paper’s evidence supports reconsideration of the Federal Reserve’s reliance on XFE as its primary core inflation guide during periods with large, sectoral price dislocations.

Source: Measuring U.S. Core Inflation: The Stress Test of COVID-19 (IMF Working Papers).