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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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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. Shiratsuka, Shigenori, 1999. "Asset Price Fluctuation and Price Indices," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, Institute for Monetary and Economic Studies, Bank of Japan, vol. 17(3), pages 103-128, December.
  2. Michael F. Bryan & Stephen G. Cecchetti, 1993. "The consumer price index as a measure of inflation," Economic Review, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, issue Q IV, pages 15-24.
  3. Goodhart, Charles & Hofmann, Boris, 2000. "Do Asset Prices Help to Predict Consumer Price Inflation?," Manchester School, University of Manchester, University of Manchester, vol. 68(0), pages 122-40, Supplemen.
  4. 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.
  5. Stephen G. Cecchetti, 1997. "Measuring short-run inflation for central bankers," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue May, pages 143-155.
  6. Alchian, Armen A & Klein, Benjamin, 1973. "On a Correct Measure of Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 5(1), pages 173-91, Part I Fe.
  7. Mark A. Wynne, 1999. "Core inflation: a review of some conceptual issues," Working Papers, Federal Reserve Bank of Dallas 9903, Federal Reserve Bank of Dallas.
  8. Hiroshi Shibuya, 1992. "Dynamic Equilibrium Price Index: Asset Price and Inflation," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, Institute for Monetary and Economic Studies, Bank of Japan, vol. 10(1), pages 95-109, February.
  9. Tullock, Gordon, 1979. "When Is Inflation Not Inflation: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 11(2), pages 219-21, May.
  10. 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.
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Cited by:
  1. 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, Elsevier, vol. 21(1), pages 88-105, March.
  2. Reis, Ricardo, 2005. "A cost-of-living dynamic price index, with an application to indexing retirement accounts," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5394, C.E.P.R. Discussion Papers.
  3. 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, Springer, vol. 3(3), pages 327-355, September.
  4. Mark W. Watson & Ricardo Reis, 2007. "Measuring changes in the value of the numeraire," 2007 Meeting Papers, Society for Economic Dynamics 324, Society for Economic Dynamics.
  5. Eric Tymoigne, 2006. "Asset Prices, Financial Fragility, and Central Banking," Economics Working Paper Archive wp_456, Levy Economics Institute.
  6. Zenon Kontolemis G., 2002. "Money Demand in the Euro Area," IMF Working Papers 02/185, International Monetary Fund.
  7. 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.
  8. Parusan Janhorm & Chaipat Poonpatpobul & Pinrat Pongsinsirikul, 2004. "Exploring Inflation in Thailand Through Sectoral Price Settting Behavior and Underlying Trend," Working Papers, Economic Research Department, Bank of Thailand 2004-03, Economic Research Department, Bank of Thailand.
  9. M. Fase, 2007. "Notes and Communications," De Economist, Springer, Springer, vol. 155(2), pages 221-238, June.
  10. Abdelaziz Rouabah, 2007. "L'inflation et la rentabilité des actions : une relation énigmatique et un casse-tête pour les banques centrales," Économie et Prévision, Programme National Persée, Programme National Persée, vol. 177(1), pages 19-34.
  11. Ricardo Reis, 2005. "A Dynamic Measure of Inflation," NBER Working Papers 11746, National Bureau of Economic Research, Inc.
  12. 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, Central Bank of Luxembourg 18, Central Bank of Luxembourg.
  13. Atchana Waiquamdee & Pranee Sutthasri & Tientip Subhanij & Surach Tanboon, 2009. "Monetary Policy and Underlying Inflation Pressures: The Essence of Monetary Policy Design," Working Papers, Economic Research Department, Bank of Thailand 2009-11, Economic Research Department, Bank of Thailand.
  14. 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), Netherlands Central Bank, Research Department 709, Netherlands Central Bank, Research Department.
  15. 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, Economic and Social Studies, vol. 36(2), pages 157-178.
  16. I. Arnold & P.J.A. van Els & J. de Haan, 2002. "Wealth Effects and Monetary Policy," WO Research Memoranda (discontinued), Netherlands Central Bank, Research Department 719, Netherlands Central Bank, Research Department.
  17. Michael D. Bordo & David C. Wheelock, 2004. "Monetary policy and asset prices: a look back at past U.S. stock market booms," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Nov, pages 19-44.
  18. Aoki, Shuhei & Kitahara, Minoru, 2008. "Measuring the Dynamic Cost of Living Index from Consumption Data," MPRA Paper 9802, University Library of Munich, Germany.
  19. Taipalus, Katja, 2012. "Detecting asset price bubbles with time-series methods," Scientific Monographs, Bank of Finland E:47/2012, Bank of Finland.
  20. Michael D. Bordo & David C. Wheelock, 2007. "Stock market booms and monetary policy in the twentieth century," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Mar, pages 91-122.

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