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Core inflation rates: a comparison of methods based on west German data

  • Landau, Bettina
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    This study compares different methods of calculating the core inflation rate, the latter being taken as the general price trend, i.e. the persistent component of measured inflation. This price trend is therefore assumed to be free of transitory price movements. This paper focuses on an empirical analysis of data taken from the consumer price index for (western) Germany. In addition, the different methods are examined critically from a theoretical perspective, focusing on two types of procedure: statistical methods and methods based on economic theory. The latter include a new procedure which is based on the P* approach. In order to assess the advantages and disadvantages of the various approaches, certain features of the core rates are tested, i.e. to establish whether they meet certain criteria, which would determine their suitability as indicators of the price trend. The principal finding of the study is that core inflation rates – irrespective of the method chosen – are not always able to meet the requirements. The methods encounter particular difficulties with regard to avoiding bias in relation to measured inflation, these problems being aggravated when adjustments are made to account for the effects of taxation. The predictive quality with regard to measured inflation also frequently leaves a great deal to be desired. In particular, however, the methods are unable to distinguish adequately between transitory and permanent components of the inflation rate. Statistical core inflation rates perform relatively well, while core rates based on economic theory suffer, in particular, from a constant need for revision. Even so, the newly introduced P* method is convincing, at least in the latter category. Given the relatively poor overall outcome, it would appear advisable not to use core inflation rates as the sole monetary policy indicators; however, they are a useful complement to measured inflation. Moreover, rather than focusing on one method only, it would be better to combine several selected methods.

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    Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2000,04.

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    Date of creation: 2000
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    Handle: RePEc:zbw:bubdp1:4140
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    2. Laurence Ball & N. Gregory Mankiw, 1999. "Interpreting The Correlation Between Inflation And The Skewness Of Relative Prices: A Comment On Bryan And," The Review of Economics and Statistics, MIT Press, vol. 81(2), pages 197-198, May.
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    4. Michael F. Bryan & Stephen G. Cecchetti, 1993. "Measuring Core Inflation," NBER Working Papers 4303, National Bureau of Economic Research, Inc.
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    18. Ball, Laurence & Mankiw, N. Gregory, 1999. "Interpreting the Correlation Between Inflation and the Skewness of Relative Prices: A Comment on Bryan and Cecchetti," Scholarly Articles 3415439, Harvard University Department of Economics.
    19. Christine Gartner & Gert Wehinger, 1998. "Core Inflation in Selected European Union Countries," Working Papers 33, Oesterreichische Nationalbank (Austrian Central Bank).
    20. Jeffrey J. Hallman & Richard D. Porter & David H. Small, 1989. "M2 per unit of potential GNP as an anchor for the price level," Staff Studies 157, Board of Governors of the Federal Reserve System (U.S.).
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    24. Michael F. Bryan & Christopher J. Pike, 1991. "Median price changes: an alternative approach to measuring current monetary inflation," Economic Commentary, Federal Reserve Bank of Cleveland, issue Dec.
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