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Friday, December 30, 2005

Trimming to the Core of the Matter

New Economist finds research on which measure of core inflation is best:

New Economist, Measuring core inflation in US and Canada: How best can central banks measure core inflation? Two new central bank working papers shed some light. New York Fed Staff Report no. 236 by Robert Rich and Charles Steindel provides A Review of Core Inflation and an Evaluation of Its Measures. Based on the "desired attributes" of ease of design, accuracy in tracking trend inflation, and predictive content for future movements in aggregate inflation, they identify a number of possible core inflation measures. But no one measure is best:

We find that most of the candidate series, including the familiar ex-food and energy measure, demonstrate the ability to match the mean rate of aggregate inflation and track movements in its underlying trend. In the within-sample analysis, we find that core measures derived through exponential smoothing, in combination with simple measures of economic slack, have substantial explanatory content for changes in aggregate inflation several years in advance.

In the out-of-sample analysis, however, we find that no measure performs consistently well in forecasting inflation. Moreover, we document evidence of some parameter instability in the estimated forecasting models. Taken together, our findings lead us to conclude that there is no individual measure of core inflation that can be considered superior to other measures.

Meanwhile a Bank of Canada working paper by Frédérick Demers and Annie De Champlain, Forecasting Core Inflation in Canada: Should We Forecast the Aggregate or the Components?, concludes that "it remains difficult to properly model and forecast monthly core inflation in Canada" - although using disaggregate data helps.

I think the Trimmed-Mean PCE Inflation Rate from the Dallas Fed and dutifully reported by macroblog is a measure to keep an eye on. It was not part of this study.

    Posted by on Friday, December 30, 2005 at 01:00 AM in Economics, Inflation, Methodology | Permalink  TrackBack (0)  Comments (1)

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