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Asset Prices in the Measurement of Inflation

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  • Michael F. Bryan
  • Stephen G. Cecchetti
  • Roisin O'Sullivan

Abstract

The debate over including asset prices in the construction of an inflation statistic has attracted renewed attention in recent years. Virtually all of this (and earlier) work on incorporating asset prices into an aggregate price statistic has been motivated by a presumed, but unidentified transmission mechanism through which asset prices are leading indicators of inflation at the retail level. In this paper, we take an alternative, longer-term perspective on the issue and argue that the exclusion of asset prices introduces an 'excluded goods bias' in the computation of the inflation statistic that is of interest to the monetary authority. We implement this idea using a relatively modern statistical technique, a dynamic factor index. This statistical algorithm allows us to see through the excessively 'noisy' asset price data that have frustrated earlier researchers who have attempted to integrate these prices into an aggregate measure. We find that the failure to include asset prices in the aggregate price statistic has introduced a downward bias in the U.S. Consumer Price Index on the order of magnitude of roughly 1/4 percentage point annually. Of the three broad assets categories considered here -- equities, bonds, and houses -- we find that the failure to include housing prices resulted in the largest potential measurement error. This conclusion is also supported by a cursory look at some cross-country evidence.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8700.

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Date of creation: Jan 2002
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Handle: RePEc:nbr:nberwo:8700

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  1. Goodhart, Charles & Hofmann, Boris, 2000. "Do Asset Prices Help to Predict Consumer Price Inflation?," Manchester School, University of Manchester, vol. 68(0), pages 122-40, Supplemen.
  2. Robert A. Pollack, 1975. "The Intertemporal Cost of Living Index," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 4, number 1, pages 179-198 National Bureau of Economic Research, Inc.
  3. James H. Stock & Mark W. Watson, 1988. "A Probability Model of The Coincident Economic Indicators," NBER Working Papers 2772, National Bureau of Economic Research, Inc.
  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. Shigenori Shiratsuka, 1999. "Asset price fluctuation and price indices," Working Paper Series WP-99-9, Federal Reserve Bank of Chicago.
  6. Mark A. Wynne, 1999. "Core inflation: a review of some conceptual issues," Working Papers 9903, Federal Reserve Bank of Dallas.
  7. Hiroshi Shibuya, 1992. "Dynamic Equilibrium Price Index: Asset Price and Inflation," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 10(1), pages 95-109, February.
  8. Stephen G. Cecchetti, 1996. "Measuring Short-Run Inflation for Central Bankers," NBER Working Papers 5786, National Bureau of Economic Research, Inc.
  9. Alchian, Armen A & Klein, Benjamin, 1973. "On a Correct Measure of Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 5(1), pages 173-91, Part I Fe.
  10. Tullock, Gordon, 1979. "When Is Inflation Not Inflation: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(2), pages 219-21, May.
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Cited by:
  1. Róisín O’Sullivan, 2005. "House Prices in the Measurement of Inflation - An Application Using Irish Data," The Economic and Social Review, Economic and Social Studies, vol. 36(2), pages 157-178.
  2. Michael D. Bordo & David C. Wheelock, 2007. "Stock market booms and monetary policy in the twentieth century," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 91-122.
  3. M. Fase, 2007. "Notes and Communications," De Economist, Springer, vol. 155(2), pages 221-238, June.
  4. Jan-Egbert Sturm & Wolfgang Nierhaus, 2003. "Soll die Europäische Zentralbank auf Preisänderungen von Vermögenswerten reagieren?," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 56(01), pages 54-55, 01.
  5. Ricardo Reis & Mark W. Watson, 2007. "Measuring changes in the value of the numeraire," Kiel Working Papers 1364, Kiel Institute for the World Economy.
  6. Michael D. Bordo & David C. Wheelock, 2004. "Monetary Policy and Asset Prices: A Look Back at Past U.S. Stock Market Booms," NBER Working Papers 10704, National Bureau of Economic Research, Inc.
  7. Reis, Ricardo, 2005. "A cost-of-living dynamic price index, with an application to indexing retirement accounts," CEPR Discussion Papers 5394, C.E.P.R. Discussion Papers.
  8. Zenon Kontolemis G., 2002. "Money Demand in the Euro Area: Where Do We Stand (Today)?," IMF Working Papers 02/185, International Monetary Fund.
  9. Sousa, Ricardo M., 2010. "Housing wealth, financial wealth, money demand and policy rule: Evidence from the euro area," The North American Journal of Economics and Finance, Elsevier, vol. 21(1), pages 88-105, March.
  10. Abdelaziz Rouabah, 2006. "L'identité de Fisher et l'interaction entre l'inflation et la rentabilité des actions: l'importance des régimes sous-jacents aux marchés boursiers," BCL working papers 18, Central Bank of Luxembourg.
  11. I. Arnold & P.J.A. van Els & J. de Haan, 2002. "Wealth Effects and Monetary Policy," WO Research Memoranda (discontinued) 719, Netherlands Central Bank, Research Department.
  12. R.J.M. Alessie & P.J.A. van Els & L.H. Hoogduin, 2002. "The Role of Wealth in the Economy: the 2002 Annual Meeting Papers of the Royal Netherlands Economic Association," WO Research Memoranda (discontinued) 709, Netherlands Central Bank, Research Department.
  13. Duoguang Bei & Xiaoli Zhu, 2008. "A new monetary phenomenon: An analysis of the co-existence of the external appreciation and the domestic inflation of RMB," Psychometrika, Springer, vol. 3(3), pages 327-355, September.
  14. Taipalus, Katja, 2012. "Detecting asset price bubbles with time-series methods," Scientific Monographs E:47/2012, Bank of Finland.
  15. Eric Tymoigne, 2006. "Asset Prices, Financial Fragility, and Central Banking," Economics Working Paper Archive wp_456, Levy Economics Institute, The.
  16. Ricardo Reis, 2005. "A Dynamic Measure of Inflation," NBER Working Papers 11746, National Bureau of Economic Research, Inc.

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