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Evaluating measures of core inflation

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. Origin & development of a concept. 1970s oil & commodity price shocks The “Ex. Food & Energy” approach Eckstein (1981)

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Evaluating measures of core inflation

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  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 3:Track 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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