[The Trap of Statistics]③ Confusing Core Inflation: Two Indicators, Which One Should You Watch?

Statistics Korea Announces 401 Items Excluding Agricultural Products and Petroleum, 309 Items Excluding Food and Energy, Presented as Two Indices

Bank of Korea Uses Food and Energy Excluded Index to Better Reflect Core Inflation Trends

"The consumer price inflation rate is expected to continue its slowdown trend in the 2% range until July, but the core inflation rate may somewhat exceed the previous forecast path." (Bank of Korea Inflation Situation Review Meeting)

Mr. Lee Young-ho, in his 40s, came across the Statistics Korea announcement that the consumer price inflation rate entered the 2% range in June for the first time in 21 months. Having suffered from high inflation and high interest rates, Mr. Lee was pleased by the news of the recent inflation slowdown but soon became curious whether this trend would continue. Inflation needs to stabilize for the Bank of Korea to be able to lower the base interest rate. Especially since the Bank of Korea has repeatedly warned about the rigidity of the 'core inflation'?which shows the underlying trend of inflation?despite the recent slowdown, his curiosity grew. To resolve his doubts, Mr. Lee thoroughly examined the core inflation indicators but soon encountered a question. He could not determine which of the two core inflation indicators released by Statistics Korea (① Agricultural products and petroleum excluded index, ② Food and energy excluded index) should be prioritized.

Different Slowdown Speeds of Two Core Inflation Indicators

According to Statistics Korea on the 5th, in the June consumer price trends, the agricultural products and petroleum excluded index rose 4.1% year-on-year, while the food and energy excluded index rose 3.5% year-on-year. The agricultural products and petroleum excluded index's growth rate fell by 0.2 percentage points from 4.3% in May to 4.1% in June, and the food and energy excluded index's growth rate dropped by 0.4 percentage points from 3.9% in May to 3.5% in June. Although the June consumer price inflation rate recorded 2.7%, falling into the 2% range for the first time in 21 months, the gap between core inflation, which shows the underlying inflation trend, and the overall consumer price inflation rate widened from 0.6 percentage points in May to 0.8 percentage points in June. The slowdown speeds of the two core inflation indicators presented by Statistics Korea also differ.

The reason these two core inflation indicators differ is simply because the number of items they reflect is different. Core inflation refers to the underlying inflation excluding the effects of temporary supply shocks among various factors causing price changes. It is calculated by removing the fluctuating parts such as agricultural product prices and international raw material prices from the overall consumer price inflation rate. Since international oil prices can surge due to the Russia-Ukraine war or agricultural product prices can temporarily rise due to seasonal factors, these indicators are used to capture the underlying inflation trend by excluding short-term shocks or irregular factors.

In South Korea, the agricultural products and petroleum excluded index has been compiled since February 2000 as a core inflation indicator, and since the 2010 base index, the food and energy excluded index based on the OECD method has also been compiled. The agricultural products and petroleum excluded index is a Korean-style core inflation index created from 401 items excluding agricultural products and petroleum-related items out of 458 goods and services surveyed in the consumer price index. In contrast, the food and energy excluded index is compressed to 309 items out of the 458 surveyed items. For example, bread, grains, meat, fish, snacks, electricity charges, and district heating fees are included in the agricultural products and petroleum excluded index but not in the food and energy excluded index.

Bank of Korea Uses OECD Method Index for Policy Decisions

Although Statistics Korea publishes two core inflation indicators every month, the Bank of Korea uses the OECD method-based food and energy excluded index when evaluating core inflation. The Bank of Korea, which decides the base interest rate considering domestic inflation conditions, utilizes this index in its Monetary and Credit Policy Reports, Financial Stability Reports, Monetary Policy Direction resolutions, and domestic and international economic trends and outlooks. In fact, the agricultural products and petroleum excluded index is not used for policy decisions.

A Bank of Korea official stated, "The food and energy excluded index is easier to compare internationally and consists of nearly 100 fewer items than the agricultural products and petroleum excluded index, focusing on core items that better reflect the underlying inflation trend." He added, "From the perspective of 'convergence,' where the consumer price inflation rate should converge to core inflation, the OECD method is superior." When the Bank of Korea added the OECD method core inflation index in 2011, it concluded that from the perspective of 'consistency,' where the gap between consumer price inflation and core inflation should be minimized in the mid to long term, the agricultural products and petroleum excluded index was better.

Regarding the slowdown in core inflation in June, a Bank of Korea official evaluated, "There is a high possibility that consumer prices will gradually converge to core inflation, and although there has been a recent slowdown, core inflation remains at a relatively high level, which could be a sign that inflation rates may rise again in the future."