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Price Pressure Measurements for Effective Monetary Policy: Methodology and Issues

Listed author(s):
  • Vincent Lim Choon Seng

Notwithstanding several shortcomings of CPI, in the SEACEN region as in elsewhere, for pragmatic purpose, the CPI despite its many flaws is universally accepted as a policy target for monetary policy. This is justified if we examine the construction of the consumer price index itself. Even though the CPI is a noisy signal of the inflationary pressures and it may not necessarily be a good measure of the cost of livings but based on a list of criteria needed for a suitable and appropriate index, other measures of price indices do not fare as well. An important question to ask regarding the construction of CPI is whether asset and wage inflation should form an integral part of price pressure measurement. The study duly notes that it may be problematic for the authorities to implicitly include asset prices in any kind of monetary rules if such prices are highly volatile. However, bearing in mind that monetary policy action often involves long lags, it needs a forward-looking and pre-emptive dimension. Therefore, central banks need to put in considerable effort in forecasting future economic developments that may include movement of asset prices. The study also notes that the movements of wages and consumer price inflation in selected SEACEN countries show some correlated relationships and this may suggest that policy authorities may want to utilise wage and labor cost variables in forecasting CPI inflation. For effective monetary policy, the study also observes that while the debate on whether to use headline or core inflation has yet to be settled, nevertheless core inflation is a vital mean to be used as an input to policy decisions and it also serves as an important tool for communication strategies with the general public. It is also noted that even though core CPI inflation does not fully reflect price level movements, it makes a good operational inflation target because it is an index, which the monetary authorities can be held accountable. The choice of which index to use depends on what is the current rate of inflation. If inflation rate is already relatively high, it probably does not matter much which index is used to calculate inflation as this is of a secondary concern. However, in a low inflationary environment, as different choice of price measurement can yield difference results, it becomes important to use the appropriate index. Therefore, in order to overcome the limitation of the conventional CPI, superlative indices are highly recommended but as a second best solution, the study strongly suggest customising a family of consumer price indices to ensure different CPIs are aptly used for different purposes.

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This book is provided by South East Asian Central Banks (SEACEN) Research and Training Centre in its series Research Studies with number rp58 and published in 2005.
ISBN: 983-9478-45-1
Handle: RePEc:sea:rstudy:rp58
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