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Core Inflation - Why the Federal Reserve Got it Wrong

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Abstract

This paper introduces a new estimate of core inflation. Core inflation is a real time estimate of monetary inflation. Most existing core inflation estimate do not account for persistent relative price changes and are therefore likely to be poor estimates of the underlying monetary inflation rate. The proposed core inflation estimate estimates core inflation by first estimating the inflation signal in all price series from the price index with a wavelet based signal estimation algorithm. In the second step the weighted inflation average is calculated by using the expenditure weights from the price index as weights. Relative price changes are thus accounted for under the assumption that the household must apply to its long run budget restriction. The proposed estimate of core inflation is estimated using data from the United States and the United Kingdom. It is evaluated by comparing it to existing estimates of core inflation. The empirical analysis show that the proposed estimate has a smaller forecasting error of future inflation than the other estimates and that it rapidly responds to increases in monetary inflation.

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File URL: http://project.nek.lu.se/publications/workpap/Papers/WP08_19.pdf
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Bibliographic Info

Paper provided by Lund University, Department of Economics in its series Working Papers with number 2008:19.

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Length: 46 pages
Date of creation: 02 Dec 2008
Date of revision:
Handle: RePEc:hhs:lunewp:2008_019

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Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
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Related research

Keywords: Core Inflation; Signal Estimation; Wavelets;

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References

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  1. Danny Quah & Danny Quah & Shaun P. Vahey, 1995. "Measuring Core Inflation," CEP Discussion Papers dp0254, Centre for Economic Performance, LSE.
  2. Jansen M. & Bultheel A., 2001. "Empirical Bayes Approach to Improve Wavelet Thresholding for Image Noise Reduction," Journal of the American Statistical Association, American Statistical Association, vol. 96, pages 629-639, June.
  3. Quah, Danny, 1995. "Measuring Core Inflation," CEPR Discussion Papers 1153, C.E.P.R. Discussion Papers.
  4. Kevin Dowd & John Cotter, 2011. "U.S. Core Inflation: A Wavelet Analysis," Working Papers 200617, Geary Institute, University College Dublin.
  5. Nelson Edward, 2005. "The Great Inflation of the Seventies: What Really Happened?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-50, July.
  6. Robert Rich & Charles Steindel, 2005. "A review of core inflation and an evaluation of its measures," Staff Reports 236, Federal Reserve Bank of New York.
  7. Ben Hunt, 2007. "U.K. Inflation and Relative Prices Over the Last Decade: How Important was Globalization?," IMF Working Papers 07/208, International Monetary Fund.
  8. Orphanides, Athanasios, 1999. "The Quest for Prosperity Without Inflation," Working Paper Series 93, Sveriges Riksbank (Central Bank of Sweden).
  9. 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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