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The divergence between core and headline inflation: Implications for consumers’ inflation expectations

Author

Listed:
  • Arora, Vipin
  • Gomis-Porqueras, Pedro
  • Shi, Shuping

Abstract

We show that US consumer inflation expectations are formed using a variant of adaptive expectations proposed by Mankiw et al. (2004). In particular, expectations behave differently when food and energy prices rise sharply relative to other prices. Using the recently proposed test of Homm and Breitung (2012), we analyze the 1982–2010 period and identify seven periods where the headline price index of personal consumption expenditures (PCEs) move explosively relative to the core PCE. During explosive periods, consumers rely more on past inflation in forming inflation expectations as compared to non-explosive periods. The importance of considering explosive periods in forming inflation expectations is also observed when CPI measures are considered. Finally, we find that during volatile periods inflation expectations are formed similarly as in normal periods. Our results indicate that the explosive behavior of food and energy prices should be taken into consideration when designing policies that aim to anchor inflation expectations.

Suggested Citation

  • Arora, Vipin & Gomis-Porqueras, Pedro & Shi, Shuping, 2013. "The divergence between core and headline inflation: Implications for consumers’ inflation expectations," Journal of Macroeconomics, Elsevier, vol. 38(PB), pages 497-504.
  • Handle: RePEc:eee:jmacro:v:38:y:2013:i:pb:p:497-504
    DOI: 10.1016/j.jmacro.2013.07.006
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    References listed on IDEAS

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    1. N. Gregory Mankiw & Ricardo Reis & Justin Wolfers, 2004. "Disagreement about Inflation Expectations," NBER Chapters,in: NBER Macroeconomics Annual 2003, Volume 18, pages 209-270 National Bureau of Economic Research, Inc.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Which Measure of Inflation Should a Central Bank Target?
      by noreply@blogger.com (Carola) in Quantitative Ease on 2015-09-06 17:04:00

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    Cited by:

    1. Wen-Yi Chen & Yia-Wun Liang & Yu-Hui Lin, 2016. "Is the United States in the middle of a healthcare bubble?," The European Journal of Health Economics, Springer;Deutsche Gesellschaft für Gesundheitsökonomie (DGGÖ), vol. 17(1), pages 99-111, January.
    2. Wen-Yi Chen & Yia-Wun Liang & Yu-Hui Lin, 2016. "Is the United States in the middle of a healthcare bubble?," The European Journal of Health Economics, Springer;Deutsche Gesellschaft für Gesundheitsökonomie (DGGÖ), vol. 17(1), pages 99-111, January.
    3. Benjamin Wong, 2015. "Do Inflation Expectations Propagate the Inflationary Impact of Real Oil Price Shocks?: Evidence from the Michigan Survey," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(8), pages 1673-1689, December.
    4. Chen, Mei-Ping & Lin, Yu-Hui & Tseng, Chun-Yao & Chen, Wen-Yi, 2015. "Bubbles in health care: Evidence from the U.S., U.K., and German stock markets," The North American Journal of Economics and Finance, Elsevier, vol. 31(C), pages 193-205.
    5. Robert G Murphy & Adam Rohde, 2018. "Rational Bias in Inflation Expectations," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 44(1), pages 153-171, January.

    More about this item

    Keywords

    Explosive behavior; Volatile; Core inflation; Relative measure; Inflation expectations;

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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