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Measuring Short-Run Inflation for Central Bankers

  • Stephen G. Cecchetti

As central bankers intensify their focus on inflation as the primary goal of monetary policy, it becomes increasingly important to have accurate and reliable measures of changes in the aggregate price level. Measuring inflation is surprisingly difficult, involving two types of problems. Commonly used indices, such as the Consumer Price Index (CPI), contain both transitory noise and bias. Noise causes short-run changes in measured inflation to inaccurately reflect movements in long-run trends, while bias leads the long-run average change in the CPI to be too high. In this paper I propose methods of reducing both the noise and the bias in the CPI. Noise reduction is achieved by average monthly inflation in measures called trimmed means' over longer horizons. Trimmed means are statistics similar to the median that are calculated by ignoring the CPI components with extreme high and low changes each month, and averaging the rest. I find that using three month averages halves the noise, while removing the highest and lowest ten percent of the cross-sectional distribution of inflation reduces the monthly variation in inflation by one-fifth.

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File URL: http://www.nber.org/papers/w5786.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5786.

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Date of creation: Oct 1996
Date of revision:
Publication status: published as Cecchetti, Stephen G. "Measuring Short-Run Inflation For Central Bankers," FRB Saint Louis - Review, 1997, v79(3,May/Jun), 143-155.
Handle: RePEc:nbr:nberwo:5786
Note: ME
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  1. Mark A. Wynne & Fiona Sigalla, 1993. "A survey of measurement biases in price indexes," Research Paper 9340, Federal Reserve Bank of Dallas.
  2. 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.
  3. Ball, L. & Mankiw, G.H., 1992. "Relative-Price Change as Aggregate Supply Shocks," Harvard Institute of Economic Research Working Papers 1609, Harvard - Institute of Economic Research.
  4. Bell, William R & Hillmer, Steven C, 1984. "Issues Involved with the Seasonal Adjustment of Economic Time Series," Journal of Business & Economic Statistics, American Statistical Association, vol. 2(4), pages 291-320, October.
  5. David E. Lebow & John M. Roberts & David J. Stockton, 1992. "Economic performance under price stability," Working Paper Series / Economic Activity Section 125, Board of Governors of the Federal Reserve System (U.S.).
  6. Stephen G. Cecchetti & Anil K Kashyap & David W. Wilcox, 1995. "Do Firms Smooth the Seasonal in Production in a Boom? Theory and Evidence," NBER Working Papers 5011, National Bureau of Economic Research, Inc.
  7. Robert J. Gordon, 1992. "Measuring the Aggregate Price Level: Implications For Economic Performance and Policy," NBER Working Papers 3969, National Bureau of Economic Research, Inc.
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