Economics Letters 210 (2022) 110214

Contents lists available at ScienceDirect

Economics Letters
journal homepage: www.elsevier.com/locate/ecolet

The relationship between headline, core, and energy inflation: A

wavelet investigation
Federico Giri 1
Università Politecnica delle Marche, Piazzale Martelli n 8 Ancona, Italy

article info a b s t r a c t

Article history: This paper investigates if core inflation, the measure of price growth obtained excluding the more
Received 7 September 2021 volatile items such as energy and food prices, is a good approximation of headline inflation that
Received in revised form 29 November 2021 considers the entire bundle. Starting from the mid-90s, our answer is negative. From a monetary policy
Accepted 1 December 2021
perspective, this raises the issue of whether controlling core inflation is still useful to anchor medium-
Available online 7 December 2021
run inflation. Using the wavelet methodology, our analysis suggests that starting from the end of the
JEL classification: 90s core inflation is weakly correlated with headline inflation especially at the lower frequencies.
E00 Energy inflation is strongly correlated with headline inflation at a broad range of frequencies, casting
E30 doubt on its exclusion from a trend inflation measure.
E31 © 2021 Elsevier B.V. All rights reserved.
E58

Keywords:
Headline inflation
Core inflation
Energy inflation
Wavelets
Medium-run

1. Introduction The present paper exploits several advantages offered by the

An ongoing debate among central bankers is if monetary pol-
icy should rely on core inflation, the inflation rate obtained by
excluding energy and food prices, or on headline inflation that
includes such items instead. The main motivation for the exclu-
sion of these items is that, as they are commonly thought to be
the most volatile items, their inclusion can obscure the trend in
inflation and distract monetary policy from its primary objective,
the medium-run stability of inflation.
The present contribution challenges the vision that core infla-
tion is a good approximation of headline inflation and provides
evidence that energy inflation is strongly correlated with headline
inflation at a broad range of frequencies, casting doubt on its
exclusion from a trend inflation measure. This is not an isolated
position. Lenza (2011), Bullard (2011), Arora et al. (2013), Bradley
et al. (2015), and Verbrugge (2021) are sceptical that core infla-
tion is a good signal of overall inflation over the medium-term
horizon.
E-mail address: f.giri@staff.univpm.it.
1 The author would like to thank Luca Edoardo Fierro for his useful
comments, an anonymous referee and the Associated Editor for their useful
comments and suggestions. This paper previously circulated under the name
‘‘Headline vs core inflation: a wavelet investigation’’. All errors remain mine.
wavelet methodology (Aguiar-Conraria and Soares, 2014), in par-
ticular, the possibility to detect the correlation between two
variables not only over time but also – simultaneously – de-
composing this correlation by frequencies. This is particularly
helpful in the present context since monetary policy focuses on
the medium-run horizon.2
2. Data
Data on different inflation measures are gathered from the
Federal Reserve of St. Louis database (FRED). The data appendix
provides a short description of each series used in the exercise.
All data are transformed into year-to-year growth rates and they
cover a time span from January 1968 to June 2021 (see left
panel of Fig. 1). The right panel of Fig. 1 shows the correlation
coefficients of headline inflation with respect to core inflation
(blue solid line), the energy component (red dashed line), and the
food component (black dotted line). The correlation coefficients
are calculated on a rolling window basis of 60 months (5 years).3
2 Some examples of wavelet applications in economics and finance
are: Aguiar-Conraria et al. (2018) and Faria and Verona (2020).
3 The rolling windows correlation coefficients are calculated using the
code provided by David J. Mack downloadable at https://www.mathworks.
com/matlabcentral/fileexchange/65342-movcorr-x-y-k-varargin-compute-
windowed-correlation-coefficient.

https://doi.org/10.1016/j.econlet.2021.110214
0165-1765/© 2021 Elsevier B.V. All rights reserved.
F. Giri
Fig. 1. Inflation measures and correlation coefficients. Right panel: Headline (black), core (red), and food (green) inflation are recorded on the left y-axis. Energy
inflation (blue) is recorded on the right y-axis. Left panel: the blue solid line is the correlation between headline and core inflation, the dashed red line is the
correlation between headline and energy inflation, the dotted black line is the correlation between headline and food inflation. The length of the rolling window is
60 months (5 years). (For interpretation of the references to colour in this figure legend, the reader is referred to the web version of this article.)
The analysis of the correlation coefficients shows that headline
and core inflation are highly correlated (ρ > 0.5) from the
beginning of the sample until 1995. After 1995, the correlation
weakens and it remains below 0.5 for almost the rest of the
sample. The food inflation correlation coefficient follows a similar
pattern albeit more volatile. On the contrary, the correlation
coefficient between headline and energy inflation remains very
high across the entire sample.
To sum up, the analysis suggests that core inflation is only
weakly correlated with headline inflation starting from the mid-
90s. At a high level, this raises questions about whether it is a
useful signal.
3. Wavelet methodology and analysis
The wavelet methodology can inform us about the partic-
ular frequencies that are responsible for the change in overall
correlation. Perhaps it is the case that headline is now being
driven by high-frequency noise in energy, which weakens the
overall correlation with core inflation — but the low-frequency
relationship between core and headline continues to be strong.
Our results reject this conjecture.
Due to space limitations, a full description of the wavelet
techniques is beyond the scope of this short introduction. For
the interested readers, the survey of Aguiar-Conraria and Soares
(2014) and Crowley (2007) are excellent starting points.
The present paper makes use of the continuous wavelet trans-
form and in particular of the wavelet coherence computed as the
local correlation between variable X and Y both in time and fre-
quency. Graphically, the darker (colder) area is the combination of
time (x-axis) and frequency (y-axis, converted in years from the
original monthly frequency) where the local correlation among
two variables is higher (lower) at different significance intervals
(1%, green, 5%, black, and 10%, white contour).
The left column of Fig. 2 presents the wavelet coherence
between headline inflation and core, energy, and food inflation,
respectively.4 Smets (2003) argues that the medium-run horizon
of monetary policy varies between 4 and 8 years. This span
approximately corresponds to the frequency bands between 3
and 11 years. Headline and core inflation are highly correlated
at the frequency band that goes between 3 and 11 years in the
4 Fig. 2 is obtained using the ASToolbox2018 developed by M. Joana
Soares and L. Aguiar-Conraria downloadable at https://sites.google.com/site/
aguiarconraria/joanasoares-wavelets/the-astoolbox.
2
Economics Letters 210 (2022) 110214
time span between 1970 until 2005.5 However, after 2005, the
correlation starts to decay becoming non-significant after 2010
undermining the argument that controlling core inflation allows
central bankers to anchor inflation in the medium term. On the
contrary, the coherence between headline and energy inflation
is weak in the first part of the sample until 1985 at frequencies
lesser than 3 years. After 1985, the local correlation became
highly significant at the higher frequencies. At the frequency
bands between 3 and 11 years, headline and energy inflation are
correlated for the whole sample. Finally, the correlation between
headline and food inflation appears to be negligible across the
entire sample.
The right column of Fig. 2 presents a robustness exercise using
a traditional band-pass filter (see Christiano and Fitzgerald, 2003).
The blue line corresponds to the correlation between headline,
core, energy, and food inflation at the frequency band between
3 and 11 years while the red dashed line is the short-run cor-
relation, between 4 months and 3 years. The results confirm
the importance of the medium-run frequency in shaping the
correlation between headline and core inflation and the relative
decline after 2000. The correlation between headline and energy
is mainly driven by the shorter frequencies but medium-term
still play a significant role with a correlation coefficient above 0.8
for almost the entire sample. The results are much less clear for
headline and food inflation.
4. Conclusion
This paper presents two main results using US data: first, start-
ing from the mid-90s the correlation between core and headline
inflation strongly weakens. Second, energy inflation is correlated
with headline inflation not only at a short-term horizon but also
at lower frequencies. These findings cast doubts on the use of core
inflation by central banks as an appropriate signal of headline
inflation.
Data appendix
• Food consumer price index: Consumer Price Index for All
Urban Consumers: Food and Beverages in U.S. City Average,
Index 1982–1984=100, Monthly, Seasonally Adjusted.
5 As a robustness check, we use alternative measures of core inflation such
as the trimmed CPI and the median CPI for the US (Mertens, 2016), which in
principle should cohere more closely to headline CPI at low frequencies. But for
these measures as well, low-frequency correlation vanishes shortly after 2010.
F. Giri Economics Letters 210 (2022) 110214

Fig. 2. Wavelet coherence (left) and band-pass filter correlation coefficients (right), 1970–2021. Left column: time is recorded on the x-axis and the frequencies are
recorded on the y-axis. Frequencies are converted in years from the monthly original recording. Blue stands for lower coherence and red for higher coherence. 99%,
95%, and 90% confidence intervals are plotted as contours in green, black, and white, respectively. The thick black lines are the cone of influence. Right Column: rolling
correlation coefficients over a five years window obtained using the (Christiano and Fitzgerald, 2003) filter. The blue line represents the medium-term frequencies
(3yr–11yr) while the red dashed line the short-term frequencies (4ms-3yr). (For interpretation of the references to colour in this figure legend, the reader is referred
to the web version of this article.)

• Energy consumer price index: Consumer Price Index for All
Urban Consumers: Energy in U.S. City Average, Index 1982-
1984=100, Monthly, Seasonally Adjusted.
• Headline consumer price index: Consumer Price Index for
All Urban Consumers: All Items in U.S. City Average, Index
1982–1984=100, Monthly, Seasonally Adjusted.
• Core consumer price index: Consumer Price Index for All
Urban Consumers: All Items Less Food and Energy in U.S. City
Average, Index 1982-1984=100, Monthly, Seasonally Adjusted.
Appendix A. Supplementary data
Supplementary material related to this article can be found
online at https://doi.org/10.1016/j.econlet.2021.110214.
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