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Asset Prices in the Measurement of Inflation

  • M.F. Bryan
  • S.G. Cecchetti
  • R. O'Sullivan

The debate over including asset prices in the construction of an inflation statistic has attracted renewed attention in recent years. Virtually all of this (and earlier) work on incorporating asset prices into an aggregate price statistic has been motivated by a presumed, but unidentified transmission mechanism through which asset prices are leading indicators of inflation at the retail level. In this paper, we take an alternative, longer-term perspective on the issue and argue that the exclusion of asset prices introduces an "excluded goods bias" in the computation of the inflation statistic that is of interest to the monetary authority. We implement this idea using a relatively modern statistical technique, a dynamic factor index. This statistical algorithm allows us to see through the excessively "noisy" asset price data that have frustrated earlier researchers who have attempted to integrate these prices into an aggregate measure. We find that the failure to include asset prices in the aggregate price statistic has introduced a downward bias in the U.S. Consumer Price Index on the order of magnitude of roughly � percentage point annually. Of the three broad assets categories considered here-- equities, bonds, and houses--we find that the failure to include housing prices resulted in the largest potential measurement error. This conclusion is also supported by a cursory look at some cross-country evidence.

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File URL: http://www.dnb.nl/binaries/sr062_tcm46-146839.pdf
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Paper provided by Netherlands Central Bank in its series DNB Staff Reports (discontinued) with number 62.

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Length: 41 pages
Date of creation: 2001
Date of revision:
Handle: RePEc:dnb:staffs:62
Contact details of provider: Postal: Postbus 98, 1000 AB Amsterdam
Web page: http://www.dnb.nl/en/

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  1. Mark A. Wynne, 2008. "Core inflation: a review of some conceptual issues," Review, Federal Reserve Bank of St. Louis, issue May, pages 205-228.
  2. Shiratsuka, Shigenori, 1999. "Asset Price Fluctuation and Price Indices," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 17(3), pages 103-128, December.
  3. Michael F. Bryan & Stephen G. Cecchetti, 1993. "The Consumer Price Index as a Measure of Inflation," NBER Working Papers 4505, National Bureau of Economic Research, Inc.
  4. Robert A. Pollack, 1975. "The Intertemporal Cost of Living Index," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 4, number 1, pages 179-198 National Bureau of Economic Research, Inc.
  5. Goodhart, Charles & Hofmann, Boris, 2000. "Do Asset Prices Help to Predict Consumer Price Inflation?," Manchester School, University of Manchester, vol. 68(0), pages 122-40, Supplemen.
  6. Tullock, Gordon, 1979. "When Is Inflation Not Inflation: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(2), pages 219-21, May.
  7. Alchian, Armen A & Klein, Benjamin, 1973. "On a Correct Measure of Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 5(1), pages 173-91, Part I Fe.
  8. Stephen G. Cecchetti, 1996. "Measuring Short-Run Inflation for Central Bankers," NBER Working Papers 5786, National Bureau of Economic Research, Inc.
  9. Hiroshi Shibuya, 1992. "Dynamic Equilibrium Price Index: Asset Price and Inflation," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 10(1), pages 95-109, February.
  10. James H. Stock & Mark W. Watson, 1988. "A Probability Model of The Coincident Economic Indicators," NBER Working Papers 2772, National Bureau of Economic Research, Inc.
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