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A review of core inflation and an evaluation of its measures

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  • Robert Rich
  • Charles Steindel

Abstract

This 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.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 236.

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Date of creation: 2005
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Handle: RePEc:fip:fednsr:236

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Keywords: Inflation (Finance) ; Consumer price indexes ; Consumption (Economics);

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References

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  1. Ghysels, E. & Guay, A. & Hall, A., 1995. "Predictive Tests for Structural Change with Unknown Breakpoint," Cahiers de recherche 9524, Universite de Montreal, Departement de sciences economiques.
  2. Smith, Julie K, 2004. "Weighted Median Inflation: Is This Core Inflation?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(2), pages 253-63, April.
  3. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May.
  4. Michael Dotsey & Thomas Stark, 2005. "The relationship between capacity utilization and inflation," Business Review, Federal Reserve Bank of Philadelphia, issue Q2, pages 8-17.
  5. Jim Dolmas, 2005. "Trimmed mean PCE inflation," Working Papers 0506, Federal Reserve Bank of Dallas.
  6. Mark A. Wynne, 2008. "Core inflation: a review of some conceptual issues," Review, Federal Reserve Bank of St. Louis, issue May, pages 205-228.
  7. Michael F. Bryan & Stephen G. Cecchetti, 1994. "Measuring Core Inflation," NBER Chapters, in: Monetary Policy, pages 195-219 National Bureau of Economic Research, Inc.
  8. Hogan, Seamus & Marianne Johnson & Thérèse Laflèche, 2001. "Core Inflation," Technical Reports 89, Bank of Canada.
  9. Robert J. Gordon, 1975. "Alternative Responses of Policy to External Supply Shocks," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(1), pages 183-206.
  10. Marianne Baxter & Robert G. King, 1999. "Measuring Business Cycles: Approximate Band-Pass Filters For Economic Time Series," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 575-593, November.
  11. Robalo Marques, Carlos & Duarte Neves, Pedro & Morais Sarmento, Luis, 2003. "Evaluating core inflation indicators," Economic Modelling, Elsevier, vol. 20(4), pages 765-775, July.
  12. Todd E. Clark, 2001. "Comparing measures of core inflation," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 5-31.
  13. Stephen G. Cecchetti & Rita S. Chu & Charles Steindel, 2000. "The unreliability of inflation indicators," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 6(Apr).
  14. Cogley, Timothy, 2002. "A Simple Adaptive Measure of Core Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 94-113, February.
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