Abstract:Policymakers tend to focus on core inflation measures because they are thought to be better predictors of total inflation over time horizons of import to policymakers. We find little support for this assumption. While some measures of core inflation are less volatile than total inflation, core inflation is not necessarily the best predictor of total inflation. The relative forecasting performance of models using core inflation and those using only total inflation depends on the inflation measure and time horiz… Show more
“…A good example of the differing views regarding headline and core inflation can be found by comparing Smith () and Crone et al. (). While the former argues in favor of using core inflation to forecast the rate of inflation in the U.S. the latter holds that core inflation is not necessarily the best predictor of total inflation and that the forecasting performance depends on the inflation measure and forecasting horizon.…”
We investigate the asymmetric relationships between aggregate inflation and the second and third moments of the cross-sectional distribution of relative prices using a modified Calvo pricing model with regime-dependent price rigidities. Calibration experiments reveal that the inflation-standard deviation and inflation-skewness relationships exhibit U-shaped asymmetries around the historical mean inflation rate. UK sectoral data support our results. We conclude that monetary policy should target an inflation rate proximate to the (common) minima of these nonlinear relationships and that core inflation measures should not be used for policy purposes as they exclude much of the information contained in the higher moments.JEL codes: E31, E52
“…A good example of the differing views regarding headline and core inflation can be found by comparing Smith () and Crone et al. (). While the former argues in favor of using core inflation to forecast the rate of inflation in the U.S. the latter holds that core inflation is not necessarily the best predictor of total inflation and that the forecasting performance depends on the inflation measure and forecasting horizon.…”
We investigate the asymmetric relationships between aggregate inflation and the second and third moments of the cross-sectional distribution of relative prices using a modified Calvo pricing model with regime-dependent price rigidities. Calibration experiments reveal that the inflation-standard deviation and inflation-skewness relationships exhibit U-shaped asymmetries around the historical mean inflation rate. UK sectoral data support our results. We conclude that monetary policy should target an inflation rate proximate to the (common) minima of these nonlinear relationships and that core inflation measures should not be used for policy purposes as they exclude much of the information contained in the higher moments.JEL codes: E31, E52
“…According to Crone, Khettry, Mester and Novak (2013) this is the prevailing view. In fact, food and energy components have been historically highly volatile (for example, due to temporary supply disruptions), and their large price fluctuations are usually expected to correct themselves within a relatively short period of time.…”
We explore the ability of traditional core inflation -consumer prices excluding food and energy-to predict headline CPI annual inflation. We analyze a sample of OECD and non-OECD economies using monthly data from January 1994 to March 2015. Our results indicate that sizable predictability emerges for a small subset of countries. For the rest of our economies predictability is either subtle or undetectable. These results hold true even when implementing an out-of-sample test of Granger causality especially designed to compare forecasts from nested models. Our findings partially challenge the common wisdom about the ability of core inflation to forecast headline inflation, and suggest a careful weighting of the traditional exclusion of food and energy prices when assessing the size of the monetary stimulus.JEL Codes: E31, E17, E37, E52, E58
“…Meyer and Pasaogullari (2010) …nd the median and the 16% trimmed-mean CPI forecast year-ahead headline in ‡ation about as well as in ‡ation expectations do, and outperform simple forecasting models. Crone, Khettry, Mester, and Novak (2013) found that over longer-horizons (i.e. 24-months), the median CPI yields a forecast signi…cantly superior to that of the headline or ex food and energy CPI index.…”
Section: Introductionmentioning
confidence: 95%
“…The lowest RMSE belongs to x 43;49 , which is the trimmed-mean CPI that excludes 43 percent of the lower tail and nearly all (49 percent) of the upper tail. The contour plot reveals a small area (in royal blue), just shy of the symmetric trim (the black line) where all of these trimmed-mean measures have a RMSE between 2.0 and 2.5 11. That next swath (lighter blue) ranges from a RMSE of 2.5 and 3.0.…”
This paper reinvestigates the performance of trimmed-mean inflation measures some 20 years since their inception, asking whether there is a particular trimmed-mean measure that dominates the median consumer price index (CPI). Unlike previous research, we evaluate the performance of symmetric and asymmetric trimmed means using a well known equality of prediction test. We find that there is a large swath of trimmed means that have statistically indistinguishable performance. Also, although the swath of statistically similar trims changes slightly over different sample periods, it always includes the median CPI-an extreme trim that holds conceptual and computational advantages. We conclude with a simple forecasting exercise that highlights the advantage of the median CPI (and trimmed-mean estimators in general) relative to other standard measures in forecasting headline inflation.
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