Headline inflation and core inflation

As soon as commodity prices stop rising, headline inflation will fall. But as companies defend their profit margins and employees defend their purchasing power, core inflation will continue to rise, for a period that depends on the formation of inflation expectations. If commodity prices stabilise, we will now enter this phase where headline inflation will fall while core inflation will rise. The duration of this phase will be all the longer as it will take time for employees to recover the purchasing power they initially lost. Central banks’ behaviour during this period will depend crucially on their choice between a headline inflation target and an “endogenous” , core inflation target. The prudent choice, which prevents inflation from permanently taking hold, is endogenous inflation, which requires maintaining a restrictive monetary policy even if headline inflation declines.