Underlying inflation, commodity prices and recent monetary policy

Abstract

The aim of monetary policy is to promote price stability over the medium term, which is the relevant time horizon from a monetary policy perspective. The main reason for the choice of the medium term is that monetary policy tools cannot generally influence average prices in the economy in the short term. In order that monetary policy decision-makers can have at their disposal the best information on the processes that determine medium-term price trends, assessments also draw on the figures for underlying inflation, from which certain prices have been removed. Calculated thus, underlying inflation should reflect less the more unstable elements of the price basket, which can be assumed to have only a short-term effect on overall price trends. Hence, the reason underlying inflation is monitored and used in setting monetary policy is not that central bank governors themselves do not eat or drive a car. The practice is based on the fact that food and energy prices fluctuate vigorously and possibly do not reveal much about future price trends more generally.