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A Measure of Underlying Inflation in the United States

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  • Claus, I.

Abstract

A monetary authority with the primary objective of price stability has to distinguish between temporary price shocks and persistent shocks to the rate of inflation. A measure of underlying inflation, therefore, has an important role to play as a guideline for monetary policy. In this paper, a measure of underlying inflation in the United States is obtained using a structural vector autoregressive (SVAR) methodology. The assumption that movements in measured inflation are the result of (a) one-time shocks to prices arising from supply-side developments and (b) persistent shocks to the inflation rate arising from demand-side developments provides a set of long-run restrictions to identify the structural innovations to the consumer price inflation rate. The model is estimated with monthly data and includes consumer prices (CPI), capacity utilization (CAPUT), producer prices of finished consumer goods (PPI), and import prices (IMP). The evidence reported in this paper suggests that measured inflation in the United States was below its underlying trend rate in 1994 and 1995, a period when inflationary pressures remained subdued, despite above-potential growth and labour market tightness. The evidence also supports the view that temporary factors have helped to contain inflationary tendencies in recent years. Past shocks should exert some further downward pressure on the inflation rate. Moreover, we find that the tightening in 1994­95 coincided with an upward trend in the underlying inflation rate, while measured inflation was still trending downward. The finding supports the view that the Federal Reserve reacts to movements in the underlying trend inflation rate.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 97-20.

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Length: 35 pages
Date of creation: 1997
Date of revision:
Handle: RePEc:bca:bocawp:97-20

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Keywords: Inflation and prices; International topics;

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References

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  1. Donald W.K. Andrews, 1990. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Cowles Foundation Discussion Papers 943, Cowles Foundation for Research in Economics, Yale University.
  2. Danny Quah & Shaun Vahey, 1995. "Measuring Core Inflation," Bank of England working papers 31, Bank of England.
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  11. James G. MacKinnon, 2010. "Critical Values for Cointegration Tests," Working Papers 1227, Queen's University, Department of Economics.
  12. Mary G. Finn, 1996. "A theory of the capacity utilization/inflation relationship," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 67-86.
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Citations

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Cited by:
  1. Mark A. Wynne, 1999. "Core inflation: a review of some conceptual issues," Working Papers 9903, Federal Reserve Bank of Dallas.
  2. C.K. Folkertsma & K. Hubrich, 2001. "Performance of core inflation measures," DNB Staff Reports (discontinued) 63, Netherlands Central Bank.
  3. Pascal Jacquinot, 2001. "L’inflation sous-jacente en France, en Allemagne et Royaume-Uni," Économie et Prévision, Programme National Persée, vol. 147(1), pages 171-185.
  4. Luis J. Álvarez & María de los Llanos Matea, 1999. "Underlying Inflation Measures in Spain," Banco de Espa�a Working Papers 9911, Banco de Espa�a.
  5. Bermingham, Colin, 2006. "How Useful is Core Inflation for Forecasting Headline Inflation?," Research Technical Papers 11/RT/06, Central Bank of Ireland.
  6. Colin Bermingham, 2007. "How Useful is Core Inflation for Forecasting Headline Inflation?," The Economic and Social Review, Economic and Social Studies, vol. 38(3), pages 355–377.
  7. Landau, Bettina, 2000. "Core inflation rates: a comparison of methods based on west German data," Discussion Paper Series 1: Economic Studies 2000,04, Deutsche Bundesbank, Research Centre.
  8. Jamie Armour, 2006. "An Evaluation of Core Inflation Measures," Working Papers 06-10, Bank of Canada.
  9. Martha Misas A>rango & Enrique López Enciso & Juana Téllez Corredor & José Fernando Escobar Restrepo, 2005. "La Inflación Subyacente En Colombia: Un Enfoque De Tendencias Estocásticas Comunes Asociadas A Un Vec Estructural," BORRADORES DE ECONOMIA 003026, BANCO DE LA REPÚBLICA.
  10. Scott Roger, 1998. "Core inflation: concepts, uses and measurement," Reserve Bank of New Zealand Discussion Paper Series G98/9, Reserve Bank of New Zealand.
  11. Mark S Astley & Tony Yates, 1999. "Inflation and real disequilibria," Bank of England working papers 103, Bank of England.

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