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How important is the financial sector to price indices in an inflation targeting regime? An empirical analysis of the UK and the US

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  • Imran Hussain Shah

    () (University of Bath)

  • Ahmad Hassan Ahmad

    (Loughborough University)

Abstract

Abstract This paper investigates whether there are benefits in terms of higher economic stability from incorporating stock prices into the price index targeted by the central banks. It also looks into the question of whether central banks should use stock prices as a component of the output stability index and how the index can be constructed. An optimization technique is employed to estimate weights for the various sectoral prices. The obtained weights, which depend on sectoral parameters, differ from those used in the construction of the consumer price index, CPI. Using data from the UK and the US, our analysis demonstrates that in comparison to the CPI, our measure of inflation leads to a higher output stability. Thus, in an inflation-targeting monetary policy environment, it is important to adopt a broader inflation benchmark than the CPI for the general macroeconomic stability.

Suggested Citation

  • Imran Hussain Shah & Ahmad Hassan Ahmad, 2017. "How important is the financial sector to price indices in an inflation targeting regime? An empirical analysis of the UK and the US," Review of Quantitative Finance and Accounting, Springer, vol. 48(4), pages 1063-1082, May.
  • Handle: RePEc:kap:rqfnac:v:48:y:2017:i:4:d:10.1007_s11156-016-0578-9
    DOI: 10.1007/s11156-016-0578-9
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Imran H. Shah & Ian Corrick & Abdul Saboor, 2018. "How should Central Banks Respond to Non-neutral Inflation Expectations?," Open Economies Review, Springer, vol. 29(2), pages 321-351, April.
    2. Imran Hussain Shaha & Simón Sosvilla-Rivero, 2017. "Seeking price and macroeconomic stabilisation in the euro area: The role of house prices and stock prices," Working Papers del Instituto Complutense de Estudios Internacionales 1707, Universidad Complutense de Madrid, Instituto Complutense de Estudios Internacionales.

    More about this item

    Keywords

    Stock prices; Output stability index; Inflation targeting; Fundamental; Bubbles;

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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