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It’s not just for inflation: The usefulness of the median CPI in BVAR forecasting

  • Brent Meyer
  • Saeed Zaman

In this paper we investigate the forecasting performance of the median CPI in a variety of Bayesian VARs (BVARs) that are often used for monetary policy. Until now, the use of trimmed-mean price statistics in forecasting inflation has often been relegated to simple univariate or “Philips-Curve” approaches, thus limiting their usefulness in applications that require consistent forecasts of multiple macro variables. We find that inclusion of an extreme trimmed-mean measure—the median CPI—significantly improves the forecasts of both headline and core CPI. across our wide-ranging set of BVARs. While the inflation forecasting improvements are perhaps not surprising given the current literature on core inflation statistics, we also find that inclusion of the median CPI improves the forecasting accuracy of the central bank’s primary instrument for monetary policy—the federal funds rate. We conclude with a few illustrative exercises that highlight the usefulness of using the median CPI.

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Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 1303.

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Date of creation: 2013
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Handle: RePEc:fip:fedcwp:1303
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  1. Laurence M. Ball & Sandeep Mazumder, 2011. "Inflation Dynamics and the Great Recession," NBER Working Papers 17044, National Bureau of Economic Research, Inc.
  2. Michael F. Bryan & Stephen G. Cecchetti, 1993. "Measuring Core Inflation," NBER Working Papers 4303, National Bureau of Economic Research, Inc.
  3. Michael F. Bryan & Stephen G. Cecchetti & Rodney L. Wiggins II, 1997. "Efficient inflation estimation," Working Paper 9707, Federal Reserve Bank of Cleveland.
  4. Robert B. Litterman, 1985. "Forecasting with Bayesian vector autoregressions five years of experience," Working Papers 274, Federal Reserve Bank of Minneapolis.
  5. Alan K. Detmeister, 2011. "The usefulness of core PCE inflation measures," Finance and Economics Discussion Series 2011-56, Board of Governors of the Federal Reserve System (U.S.).
  6. Brent Meyer & Mehmet Pasaogullari, 2010. "Simple ways to forecast inflation: what works best?," Economic Commentary, Federal Reserve Bank of Cleveland, issue Dec.
  7. Todd Clark & Michael W. McCracken, 2011. "Tests of equal forecast accuracy for overlapping models," Working Paper 1121, Federal Reserve Bank of Cleveland.
  8. Domenico Giannone & Martha Banbura & Lucrezia Reichlin, 2008. "Bayesian VARs with large panels," ULB Institutional Repository 2013/13388, ULB -- Universite Libre de Bruxelles.
  9. Brent Meyer & Guhan Venkatu, 2012. "Trimmed-mean inflation statistics: just hit the one in the middle," Working Paper 1217, Federal Reserve Bank of Cleveland, revised 01 Feb 2014.
  10. Andrea Carriero & Todd Clark & Massimiliano Marcellino, 2011. "Bayesian VARs: specification choices and forecast accuracy," Working Paper 1112, Federal Reserve Bank of Cleveland.
  11. Kenneth Beauchemin & Saeed Zaman, 2011. "A medium scale forecasting model for monetary policy," Working Paper 1128, Federal Reserve Bank of Cleveland.
  12. Kadiyala, K. Rao & Karlsson, Sune, 1994. "Numerical Aspects of Bayesian VAR-modeling," SSE/EFI Working Paper Series in Economics and Finance 12, Stockholm School of Economics.
  13. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 253-63, July.
  14. David Norman & Anthony Richards, 2012. "The Forecasting Performance of Single Equation Models of Inflation," The Economic Record, The Economic Society of Australia, vol. 88(280), pages 64-78, 03.
  15. Sims, Christopher A & Zha, Tao, 1998. "Bayesian Methods for Dynamic Multivariate Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 949-68, November.
  16. Harvey, David I & Leybourne, Stephen J & Newbold, Paul, 1998. "Tests for Forecast Encompassing," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(2), pages 254-59, April.
  17. Smith, Julie K, 2004. "Weighted Median Inflation: Is This Core Inflation?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(2), pages 253-63, April.
  18. Jim Dolmas, 2005. "Trimmed mean PCE inflation," Working Papers 0506, Federal Reserve Bank of Dallas.
  19. Marta Bańbura, 2008. "Large Bayesian VARs," 2008 Meeting Papers 334, Society for Economic Dynamics.
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