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Measuring short-run inflation for central bankers

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  • Stephen G. Cecchetti

Abstract

As central bankers intensify their focus on inflation as the primary goal of monetary policy, it becomes increasingly important to have accurate and reliable measures of changes in the aggregate price level. Measuring inflation is surprisingly difficult, involving two types of problems. Commonly used indices, such as the Consumer Price Index (CPI), contain both transitory noise and bias. Noise causes short-run changes in measured inflation to inaccurately reflect movements in long-run trends, while bias leads the long-run average change in the CPI to be too high. In this paper I propose methods of reducing both the noise and the bias in the CPI. Noise reduction is achieved by average monthly inflation in measures called trimmed means' over longer horizons. Trimmed means are statistics similar to the median that are calculated by ignoring the CPI components with extreme high and low changes each month, and averaging the rest. I find that using three month averages halves the noise, while removing the highest and lowest ten percent of the cross-sectional distribution of inflation reduces the monthly variation in inflation by one-fifth.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (1997)
Issue (Month): May ()
Pages: 143-155

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Handle: RePEc:fip:fedlrv:y:1997:i:may:p:143-155

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Keywords: Inflation (Finance) ; Monetary policy ; Banks and banking; Central;

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References

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  1. Stephen G. Cecchetti & Anil K Kashyap & David W. Wilcox, 1995. "Do Firms Smooth the Seasonal in Production in a Boom? Theory and Evidence," NBER Working Papers 5011, National Bureau of Economic Research, Inc.
  2. Bell, William R & Hillmer, Steven C, 1984. "Issues Involved with the Seasonal Adjustment of Economic Time Series," Journal of Business & Economic Statistics, American Statistical Association, vol. 2(4), pages 291-320, October.
  3. Gordon, Robert J, 1992. "Measuring the Aggregate Price Level: Implications for Economic Performance and Policy," CEPR Discussion Papers 663, C.E.P.R. Discussion Papers.
  4. Michael F. Bryan & Stephen G. Cecchetti, 1993. "The Consumer Price Index as a Measure of Inflation," NBER Working Papers 4505, National Bureau of Economic Research, Inc.
  5. Wynne, Mark A & Sigalla, Fiona D, 1996. " A Survey of Measurement Biases in Price Indexes," Journal of Economic Surveys, Wiley Blackwell, vol. 10(1), pages 55-89, March.
  6. Laurence Ball & N. Gregory Mankiw, 1993. "Relative-price changes as aggregate supply shocks," Working Papers 93-13, Federal Reserve Bank of Philadelphia.
  7. David E. Lebow & John M. Roberts & David J. Stockton, 1992. "Economic performance under price stability," Working Paper Series / Economic Activity Section 125, Board of Governors of the Federal Reserve System (U.S.).
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Measuring inflation: Signal extraction redux
    by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2014-08-21 12:16:23
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