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Inflation Issues and Measures from the Perspective of Monetary Policy

Inflation Issues and Measures from the Perspective of Monetary Policy. SEACEN-IFC Workshop October 12, 2009 Shigenori SHIRATSUKA Bank of Japan. Numerical definition of price stability Important properties of inflation measures CPI vs GDP deflator COLI vs COGI Asset prices

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Inflation Issues and Measures from the Perspective of Monetary Policy

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  1. Inflation Issues and Measures from the Perspective of Monetary Policy SEACEN-IFC Workshop October 12, 2009 Shigenori SHIRATSUKA Bank of Japan

  2. Numerical definition of price stability • Important properties of inflation measures • CPI vs GDP deflator • COLI vs COGI • Asset prices • Single vs multiple inflation measures Questions

  3. 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators Definition of Price Stability • Measured Price Stability: • Tolerable range of inflation rates • Numerical definition • Sustainable Price Stability: • Important basis for sustainable growth • Neutral to economic decision making Monetary Policy Framework: How to make these two aspects consistent in the medium to long term?

  4. 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators Numerical Definition of P-Stability • In Theory: Small but positive rate of inflation • Common understanding among academia and CB circle • In Practice: Assessments on • Upward bias in price indexes • Safety margin against deflationary spiral • Downward rigidity of nominal wages • Adverse effects on financial systems • Zero-lower-bound of nominal interest rates

  5. 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators Implications of Upward Biases Upward biases in price indexes Overestimation of inflation rates Underestimation of growth rates (Underestimation of real interest rates as well) • Better price measurement • (Correct both overestimated inflation and underestimated growth) Lower numerical target (Higher real i-rates  Smaller safety margin)

  6. CPI: widely used as an inflation measure at central banks • Minimum coverage for household expenditure • Easy to understand, compared to GDP def. • Immediacy • No retroactive revision • PCE deflator: alternative choice, used in the USA 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators CPI vs GDP Deflator

  7. Conceptual Differences: • COLI: constant utility level • COGI: constant consumption basket • Practical Differences? • COLI is unavailable at a real time basis • COLI as a benchmark to assess the CPI measurement • How to make COGI closer to COLI with readily available information in compiling CPI 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators COLI vs COGI

  8. Cost of living index (COLI) • Intertemporal COLI: Alchian and Klein (1973) • Theoretical basis for incorporating APs into price statistics • But, practical? Reliability of AP statistics? • Then, using APs as info. indicators separately? 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators Extension of Price Index ≈ asset prices

  9. 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators Japan’s AP Bubble Output CPI and Asset Prices

  10. 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators Assessment of Price Stability CPI inflation Assessment of “price stability” From the viewpoint of sustainability

  11. 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators Assessment (cont’d) • Viewpoint from Measured Price Stability: • Not Maintained: Prices eventually rose substantially toward the end of the bubble period. • Maintained: Price stability had not been undermined, compared with the past. • Viewpoint from Sustained Price Stability: • Not Maintained: the economy were on the verge of falling into a deflationary spiral in the 1990s, as a result of the emergence of the bubble economy in the late 1980s.

  12. Assessment of Price Stability: • Importance of evaluating the sustainability of price stability over a fairly long period • Importance of employing all readily available information to assess price stability in the log term • Asset prices: • One of the important information indicators, • But, not combined with inflation measures, given the lower accuracy than CPI 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators Monetary Policy Implications

  13. Time Horizon: • Assessment of P-stability: Stability of headline CPI • Analysis of P-development: extraction of underlying trend  Core CPI and other supplementary indicator • BOJ’s Practice: • Numerical expression (Understanding) of P-stability: Headline CPI • Projections of CPI: Core CPI (excl. perishables) 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators Headline vs Core

  14. 1. Numerical definition 2. Properties for inflation measures 3. Asset prices 4. Single vsmultiple indicators Extraction of Underlying Changes  Headline indicator  Core indicator • Real-time assessment • A core indicator alone is not enough • Other supplementary indicators and more detailed examination of individual prices are required

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