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Core Inflation - Why the Federal Reserve Got it Wrong




This paper introduces a new estimate of core inflation. Core inflation is a real time estimate of monetary inflation. Most existing core inflation estimate do not account for persistent relative price changes and are therefore likely to be poor estimates of the underlying monetary inflation rate. The proposed core inflation estimate estimates core inflation by first estimating the inflation signal in all price series from the price index with a wavelet based signal estimation algorithm. In the second step the weighted inflation average is calculated by using the expenditure weights from the price index as weights. Relative price changes are thus accounted for under the assumption that the household must apply to its long run budget restriction. The proposed estimate of core inflation is estimated using data from the United States and the United Kingdom. It is evaluated by comparing it to existing estimates of core inflation. The empirical analysis show that the proposed estimate has a smaller forecasting error of future inflation than the other estimates and that it rapidly responds to increases in monetary inflation.

Suggested Citation

  • Andersson, Fredrik N. G., 2008. "Core Inflation - Why the Federal Reserve Got it Wrong," Working Papers 2008:19, Lund University, Department of Economics.
  • Handle: RePEc:hhs:lunewp:2008_019

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    References listed on IDEAS

    1. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
    2. Nelson Edward, 2005. "The Great Inflation of the Seventies: What Really Happened?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-50, July.
    3. Quah, Danny & Vahey, Shaun P, 1995. "Measuring Core Inflation?," Economic Journal, Royal Economic Society, vol. 105(432), pages 1130-1144, September.
    4. Cogley, Timothy, 2002. "A Simple Adaptive Measure of Core Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 94-113, February.
    5. Dowd, Kevin & Cotter, John & Loh, Lixia, 2011. "U.S. Core Inflation: A Wavelet Analysis," Macroeconomic Dynamics, Cambridge University Press, vol. 15(04), pages 513-536, September.
    6. Benjamin L Hunt, 2007. "U.K. Inflation and Relative Prices over the Last Decade; How Important was Globalization?," IMF Working Papers 07/208, International Monetary Fund.
    7. Robert W. Rich & Charles Steindel, 2005. "A review of core inflation and an evaluation of its measures," Staff Reports 236, Federal Reserve Bank of New York.
    8. Quah, Danny & Vahey, Shaun P, 1995. "Measuring Core Inflation?," Economic Journal, Royal Economic Society, vol. 105(432), pages 1130-1144, September.
    9. Jansen M. & Bultheel A., 2001. "Empirical Bayes Approach to Improve Wavelet Thresholding for Image Noise Reduction," Journal of the American Statistical Association, American Statistical Association, vol. 96, pages 629-639, June.
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    More about this item


    Core Inflation; Signal Estimation; Wavelets;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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