Alternative Inflation Measures. Comparison: core vs. overall Overall measures: very volatile,...
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![Page 1: Alternative Inflation Measures. Comparison: core vs. overall Overall measures: very volatile, especially because of food & energy shocks Core = excluding.](https://reader035.fdocuments.net/reader035/viewer/2022062517/56649f145503460f94c284f1/html5/thumbnails/1.jpg)
Alternative Inflation Measures
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Comparison: core vs. overall
• Overall measures: very volatile, especially because of food & energy shocks
• Core = excluding food & energy here; but research works on alternatives
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Comparison across measures
• Examine GDP price index, PCE price index, CPI
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Differences between measures
• Coverage (scope)– CPI: out of pocket spending of urban
consumers– PCEPI: prices of all personal consumption
expenditures in NIPA– GDPPI: price index of prices of all goods
produced in economy (70% of which is in PCEPI)
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Differences between measures
• Weights:– PCEPI and GDPPI: weights updated every
quarter; based on business surveys (production measures)
– CPI: weights updated every two years; based on household surveys (out-of-pocket expenditure measures)
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Differences between measures
• Revisions:– PCEPI and GDPPI: revised as time passes to
better reflect true weights across sample of businesses
– CPI: never revised, except for seasonal adjustment
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Differences between measures
• Bias:– PCEPI and GDPPI: small bias because of
quality adjustment bias; around 0.5% for PCEPI and 0.4% for GDPPI
– CPI: larger bias because of quality adjustment bias and substitution bias; at least 1.0%
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Differences between measures
• Examples– Housing prices are 15% of PCEPI, but 32% of
CPI (urban)– Medical prices are 20.5% of PCEPI, but only
6.2% of CPI (out of pocket)
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• GDPPI and PCEPI are revised; CPI is not
• That means the CPI is worse, not better
Data revisions
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• Policy implications: the Fed could be confused by initial data, as it was in 2003
Data revisions
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Data revisions
• In 2000, Fed switched main variable for inflation to PCE price index (PCE inflation); in 2004 switched to PCE price index excluding food and energy prices (core PCE inflation); in 2007 it began using both
• Problem: these variables get revised• Issue: are the revisions large enough to
worry about?
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Data Revisions
• May 2002: data show decline in core PCE inflation from 2.0% in 2000Q3 to 1.2% in 2002Q1
• Academic research on deflation and the zero bound are fresh in policymakers’ minds
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Core PCE inflation rate from 1997Q1 to 2002Q1, as observed May 2002
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
1997 1998 1999 2000 2001 2002
Year
Infl
atio
n r
ate
(per
cen
t)
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Data revisions
• Perhaps as a consequence of worry about low inflation, Fed drives real fed funds rate to negative levels for first time since early 1970s
• Fed adds phrase to FOMC statement that it worries about an “unwelcome fall in inflation”
• But: revised data by December 2003 show that inflation wasn’t declining after all
v=May2002 v=Dec20032000Q3 2.0% 1.7%2002Q1 1.2% 1.5%
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Core PCE inflation rate, May 2002 and December 2003
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
1997 1998 1999 2000 2001 2002
Year
Infl
atio
n r
ate
(per
cen
t)
OBSERVED MAY 2002
OBSERVED DECEMBER 2003
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Data revisions
• The Fed gets rid of the “unwelcome fall” language by May 2004. Revised data by August 2005 show Fed should have worried about an unwelcome rise in inflation
2000Q3 2002Q1v=May 2002 2.0% 1.2%v=Dec2003 1.7% 1.5%v=Aug2005 1.6% 1.8%
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Core PCE inflation rate, May 02, Dec 03, & Aug 05
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
1997 1998 1999 2000 2001 2002
Year
Infl
atio
n r
ate
(per
cen
t)
AUGUST 2005
MAY 2002
DECEMBER 2003
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Data revisions
• Policymakers need to understand revisions to inflation
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Figure 5Four Quarter Inflation Rate in PPCEXInitial to August Revision and Actuals
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Date
Act
ual
s an
d R
evis
ion
s (p
erce
nt)
Revision
Initial
August
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Figure 6
Revisions to Four Quarter Inflation Rate in PPCE and PPCEXInitial to August Revision
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Date
Rev
isio
ns
(per
cen
t)
PPCEX
PPCE
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• The chained CPI uses chain weighting to improve on the overall CPI
• It works, but to do so, it must be revised
• Data are final after two years
• Revisions cause problems for changing payments, as in Social Security
Chained CPI
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Conclusions
• There is no perfect measure of inflation
• Fed uses multiple measures
• Using core inflation prevents overreaction to short-term shocks
• Fed should be aware of revisions
• The chained CPI is more accurate than the overall CPI