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Measuring Core Inflation

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  • Danny Quah
  • Shaun Vahey

Abstract

Many alternative measures of core, or underlying, inflation have been proposed that are based on stripping out some unwanted or excessively volatile elements from the headline rate. A potential drawback of such measures is that they are necessarily atheoretic - based largely on purely statistical procedures. This paper proposes an alternative method of measuring core inflation utilising an explicit economic definition. It defines core inflation as that part of measured inflation that has no medium or long term impact on real output - a notion that is consistent with the vertical long-run Phillips curve. This definition captures the commonly held view that moderate movements in inflation can have no impact on the real economy once financial and wage contracts have been written taking it into account. Using this definition the paper estimates a measure of core inflation using the VAR identification technique developed by Blanchard and Quah. The estimated measure indicates that core inflation was higher than measured inflation in the early 80s suggesting that measured inflation was depressed by beneficial supply shocks. The opposite effect occurred in the late 80s. Currently, core inflation is above measured inflation.

Suggested Citation

  • Danny Quah & Shaun Vahey, 1995. "Measuring Core Inflation," Bank of England working papers 31, Bank of England.
  • Handle: RePEc:boe:boeewp:31
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    References listed on IDEAS

    as
    1. Breedon, F J & Fisher, P G, 1996. "M0: Causes and Consequences," The Manchester School of Economic & Social Studies, University of Manchester, vol. 64(4), pages 371-387, December.
    2. Quah, Danny & Vahey, Shaun P, 1995. "Measuring Core Inflation?," Economic Journal, Royal Economic Society, vol. 105(432), pages 1130-1144, September.
    3. Roger Beaton & Paul Fisher, 1995. "The Construction of RPIY," Bank of England working papers 28, Bank of England.
    4. Paul Fisher & Suzanne Hudson & Mahmood Pradhan, 1993. "Divisia Indices for Money: An Appraisal of Theory and Practice," Bank of England working papers 9, Bank of England.
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    6. Andrew G Haldane & Mahmood Pradhan, 1992. "Real interest parity, dynamic convergence and the European Monetary System," Bank of England working papers 1, Bank of England.
    7. Joanna Paisley, 1994. "A Model of Building Society Interest Rate Setting," Bank of England working papers 22, Bank of England.
    8. Andrew Derry & Mahmood Pradhan, 1993. "Tax Specific Term Structures of Interest Rates in the UK Government Bond Market," Bank of England working papers 11, Bank of England.
    9. Gabriel Sterne & Tamim Bayoumi, 1993. "Regional Trading Blocs, Mobile Capital and Exchange Rate Co-ordination," Bank of England working papers 12, Bank of England.
    10. Mike Joyce, 1995. "Modelling UK Inflation Uncertainty: The Impact of News and the Relationship with Inflation," Bank of England working papers 30, Bank of England.
    11. Mark Deacon & Andrew Derry, 1994. "Deriving Estimates of Inflation Expectations from the Prices of UK Government Bonds," Bank of England working papers 23, Bank of England.
    12. Jo Corkish & David Miles, 1994. "Inflation, inflation risks and asset returns," Bank of England working papers 27, Bank of England.
    13. Chris Melliss & Mark Cornelius, 1994. "New currencies in the Former Soviet Union: a recipe for hyperinflation or the path to price stability," Bank of England working papers 26, Bank of England.
    14. Quah, Danny & Vahey, Shaun P, 1995. "Measuring Core Inflation?," Economic Journal, Royal Economic Society, vol. 105(432), pages 1130-1144, September.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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