Estimating the Common Trend Rate of Inflation for Consumer Prices and Consumer Prices Excluding Food and Energy Prices

Abstract

I examine the common trend in inflation for consumer prices and consumer prices excluding prices of food and energy. Both the personal consumption expenditure (PCE) indexes and the consumer price indexes (CPI) are examined. The statistical model employed is a bivariate integrated moving average process; this model extends a univariate model that fits the data on inflation very well. The bivariate model forecasts as well as the univariate models. The results suggest that the relationship between overall consumer prices, consumer prices excluding the prices of food and energy, and the common trend has changed significantly over time. In the 1970s and early 1980s, movements in overall prices and prices excluding food and energy prices both contained information about the trend; in recent data, the trend is best gauged by focusing solely on prices excluding food and energy prices. 2 Articles that define core inflation is this way include Bryan and Cecchetti (1994), Cogley (2002), and Rich and Steindel (2005); articles suggesting that this notion of core may be gauged by appeal to PCE prices excluding food and energy include Clark (2001) and Blinder and Reis (2005).

Core Measures of Inflation as Predictors of Total Inflation

“…Other papers have examined the forecasting ability of alternative core inflation measures for future total inflation. These include Cogley (2002), Rich and Steindel (2005), Clark (2001), Smith (2004), Kiley (2008), and Meyer and Pasaogullari (2010), among others. The findings differ across the studies, reflecting differences in the inflation measures, forecasting models, and time periods used.…”

“…Kiley (2008) uses the methodology of Stock and Watson (2007) and examines three models to extract trend CPI and trend PCE inflation. He then examines four quarter‐horizon forecasts of these trends over various sample periods (whereas our models forecast total CPI or PCE inflation).…”

Core Measures of Inflation as Predictors of Total Inflation

“…19 She also finds that median PCE outperforms the PCE and the core PCE as a predictor of future PCE. Kiley (2008) uses the methodology of Stock and Watson (2007) and examines three models to extract trend CPI and trend PCE inflation. He then examines four quarter-horizon forecasts of these trends over various sample periods (whereas our models forecast total CPI or PCE inflation).…”

"CONDI: A Cost-Of-Nominal-Distortions Index

“…The other variables are headline PCE in ‡ation, GDP growth and unemployment 2. For an extremely clear statement of this reasoning from the perspective of a policymaker seeMishkin (2007) 3 This statistical underpinning for the role of core in ‡ation in policymaking has recently received much scrutiny in the literature and in the policy debate(Blinder and Reis, 2005;Rich and Steindel, 2007; Crone et al, 2008;Kiley, 2008;and Buiter, 2008). Earlier contributions includeBryan and Cecchetti (1994),Quah and Vahey (1995),Clark (2001), and Cogley (2002) 4.…”