A Review of Core Inflation and an Evaluation of its Measures

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractThis paper provides a review of the concept of core inflation and evaluates the performance of several proposed measures. We first consider the rationale of a central bank in setting its inflation goal in terms of a selected rate of consumer price growth and the use of a core inflation measure as a means of achieving this long-term policy objective. We then discuss desired attributes of a core measure of inflation, such as ease of design, accuracy in tracking trend inflation, and predictive content for future movements in aggregate inflation. Using these attributes as criteria, we evaluate several candidate series that have been proposed as core measures of consumer price index (CPI) inflation and personal consumption expenditure (PCE) inflation for the United States. The candidate series are inflation excluding food and energy, inflation excluding energy, and median inflation, as well as exponentially smoothed versions of aggregate inflation and the aforementioned individual series.For PCE inflation, we examine quarterly data starting in 1959. Unlike previous research, we confine our analysis to the methodologically consistent CPI index, which is only available starting in 1978. We find that most of the candidate series, including the familiar ex-food and energy measure, demonstrate the ability to match the mean rate of aggregate inflation and track movements in its underlying trend. In the within-sample analysis, we find that core measures derived through exponential smoothing, in combination with simple measures of economic slack, have substantial explanatory content for changes in aggregate inflation several years in advance. In the out-of-sample analysis, however, we find that no measure performs consistently well in forecasting inflation. Moreover, we document evidence of some parameter instability in the estimated forecasting models. Taken together, our findings lead us to conclude that there is no individual measure of core inflation that can be considered superior to other measures.

The dynamic relationship between core and headline inflation

“…See Le Bihan and Sédillot (2002), Bagliano and Morana (2003) and Stardev (2010) for discussions of forecasting in Europe. 4 Differences in the dynamic relationship between core and headline inflation across a 1979 or early 1980s sample split have been identified by other authors as well: Blinder and Reis (2005), Ball andMazumder (2011), Clark (2001), Mishkin (2007), Rosengren (2011), Rich and Steindel (2005), and Smith (2005). 5 See also Benati (2008), Dossche and Everaert (2005), Hondroyiannis and Lazaretou (2004), Lansing (2009), Levin and Piger (2002), Leduc, Keith, andTom, 2007.…”

“…3 Most previous research has examined whether core inflation measures are good forecasters of future inflation. See Bryan and Cecchetti (1994), Clark (2001), Cogley (2002, Dolmas (2005), Liu and Smith (2014), Rich and Steindel (2005), Smith (2004), Wynne (1999) for discussions of forecasting in the United States. See Le Bihan and Sédillot (2002), Bagliano and Morana (2003) and Stardev (2010) for discussions of forecasting in Europe.…”

“… See Crone, Neil, Khettry, Mester, and Novak (2013),Detmeister (2011),Liu and Smith (2014),Rich and Steindel (2005),Smith (2004), which conduct various forecasting exercises with various measures of core inflation.…”

Sustainable Trends and Periodicity in Consumer Price Indices Indicate that the Era of Low Energy Prices is Approaching

“…It is a well-known fact that the monthly CPI readings reported by the BLS are highly volatile and may give misleading signals on the long-term trends (Rich and Steindel, 2005). Usually the prices of food and energy are excluded from the headline CPI in order to obtain a smoother time series.…”

Inflation Forecasting with Inflation Sentiment Indicators

“…A quite familiar concept for measuring core inflation is to exclude prices for energy and unprocessed food from the recorded basket of goods, since their prices tend to be very volatile without any trend (Gordon 1975). Alternatively, median based indicators or trimmed mean measures have been proposed (Bryan et al 1994), as well as smoothed versions of these indicators (Rich and Steindel 2005). Moreover, another suggestion is to incorporate co-integration restrictions (Smith 2004).…”