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Evaluating measures of core inflation

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Title: Evaluating measures of core inflation


1
Evaluating measures of core inflation
  • Mark A. Wynne
  • Federal Reserve Bank of Dallas
  • Presentation to International Seminar on Core
    Inflation
  • Rio de Janeiro, June 7-8 2001

2
Origin development of a concept
  • 1970s oil commodity price shocks
  • The Ex. Food Energy approach
  • Eckstein (1981)
  • 1990s revival of stochastic approach to index
    numbers
  • Selvenathan Prasada Rao
  • Bryan Cecchetti
  • Quah Vahey

3
Two new approaches
  • The common component in price changes
  • Bryan Cecchetti
  • The persistent component of price changes
  • Quah Vahey

4
A basic framework I
5
A basic framework II
6
Use of core inflation in monetary policy
  • As a target for monetary policy
  • Reserve Bank of New Zealand (until 1999), Bank of
    England, Reserve Bank of Australia (until 1998),
    Thailand
  • As an input to policy decisions
  • Fed, ECB
  • As part of communication strategy
  • Bank of England, Sveriges Riksbank

7
What is the question to which core inflation is
the answer?
  • Alternative measure of inflation
  • Domain of headline measure too broad
  • Answer to a counterfactual
  • What if?
  • A measure of trend, steady-state or inertial
    inflation

8
Criteria for evaluating measures of core inflation
  • Computable in real time
  • Forward looking
  • Track record
  • Understandable by the general public
  • History invariant to new data
  • Sound theoretical basis

9
Criterion 1 Computable in real time
  • Essential for use of core inflation
  • as target
  • as input to policy
  • as part of communication
  • Satisfied by almost all popular measures
  • Exceptions HP, BP, two-sided filters

10
Criterion 2 Forward looking
  • Inherently forward-looking measures
  • e.g. SVAR measures
  • Measures with predictive power
  • Stable long-run relationship with headline rate

11
Criterion 3Track record
  • Ex. Food Energy
  • produced by almost all countries
  • Trimmed mean
  • most popular of newer measures

12
Criterion 4 Understandable by general public
  • Essential for measure used as target
  • Important if measure used as part of
    communications strategy
  • Reproducible

13
Criterion 5 History invariant to arrival of new
data
  • True of
  • traditional Ex. Food Energy measures
  • trimmed mean
  • Problematic for
  • SVAR, DFI based measures
  • other model-based measures

14
Criterion 6 Sound basis in economic theory
  • Contrast with theory of cost of living index
  • well developed well understood
  • What is the appropriate theory for core
    inflation?
  • Quantity theory perspective on inflation
  • Long run neutrality of money

15
Concluding observations
  • Core inflation a slippery concept
  • No good theory, yet
  • Tracking trend a useful criterion for
    discriminating between measures
  • not without problems
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