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Core inflation rates: A comparison of methods based on west German data

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Author Info
Landau, Bettina
Abstract

This study compares different methods of calculating the core inflation rate, the latter being taken as the general price trend, i.e. the persistent component of measured inflation. This price trend is therefore assumed to be free of transitory price movements. This paper focuses on an empirical analysis of data taken from the consumer price index for (western) Germany. In addition, the different methods are examined critically from a theoretical perspective, focusing on two types of procedure: statistical methods and methods based on economic theory. The latter include a new procedure which is based on the P* approach. In order to assess the advantages and disadvantages of the various approaches, certain features of the core rates are tested, i.e. to establish whether they meet certain criteria, which would determine their suitability as indicators of the price trend. The principal finding of the study is that core inflation rates ? irrespective of the method chosen ? are not always able to meet the requirements. The methods encounter particular difficulties with regard to avoiding bias in relation to measured inflation, these problems being aggravated when adjustments are made to account for the effects of taxation. The predictive quality with regard to measured inflation also frequently leaves a great deal to be desired. In particular, however, the methods are unable to distinguish adequately between transitory and permanent components of the inflation rate. Statistical core inflation rates perform relatively well, while core rates based on economic theory suffer, in particular, from a constant need for revision. Even so, the newly introduced P* method is convincing, at least in the latter category. Given the relatively poor overall outcome, it would appear advisable not to use core inflation rates as the sole monetary policy indicators; however, they are a useful complement to measured inflation. Moreover, rather than focusing on one method only, it would be better to combine several selected methods.

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Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2000,04.

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Date of creation: 2000
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Handle: RePEc:zbw:bubdp1:4140

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  2. Shiratsuka, Shigenori, 1997. "Inflation Measures for Monetary Policy: Measuring the Underlying Inflation Trend and Its Implication for Monetary Policy Implementation," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 15(2), pages 1-26, December. [Downloadable!]
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    Other versions:
  4. Michael F. Bryan & Stephen G. Cecchetti & Rodney L. Wiggins II, 1997. "Efficient Inflation Estimation," NBER Working Papers 6183, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Hilde Christiane Bjørnland, 1997. "Estimating Core Inflation - The Role of Oil Price Shocks and Imported Inflation," Discussion Papers 200, Research Department of Statistics Norway. [Downloadable!]
  6. Robalo Marques, Carlos & Duarte Neves, Pedro & Morais Sarmento, Luis, 2003. "Evaluating core inflation indicators," Economic Modelling, Elsevier, vol. 20(4), pages 765-775, July. [Downloadable!] (restricted)
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  11. Blanchard, Olivier Jean & Quah, Danny, 1989. "The Dynamic Effects of Aggregate Demand and Supply Disturbances," American Economic Review, American Economic Association, vol. 79(4), pages 655-73, September. [Downloadable!] (restricted)
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  12. Diewert, W.E., 1995. "On the Stochastic Approach to Index Numbers," UBC Departmental Archives 95-31, UBC Department of Economics.
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  16. Lars E.O. Svensson, 2000. "How Should Monetary Policy be Conducted in an Era of Price Stability?," NBER Working Papers 7516, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  17. Stephen G. Cecchetti, 1997. "Measuring short-run inflation for central bankers," Review, Federal Reserve Bank of St. Louis, issue May, pages 143-155. [Downloadable!]
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  18. Jonathan Kearns, 1998. "The Distribution and Measurement of Inflation," RBA Research Discussion Papers rdp9810, Reserve Bank of Australia. [Downloadable!]
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  20. Claus, I., 1997. "A Measure of Underlying Inflation in the United States," Working Papers 97-20, Bank of Canada. [Downloadable!]
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  22. repec:wop:imespe:9707 is not listed on IDEAS
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