1. Evaluating measures of core inflation Mark A. Wynne Federal Reserve Bank of Dallas Presentation to International Seminar on Core Inflation Rio de Janeiro, June 7-8 2001

2. Origin & development of a concept 1970s oil & commodity price shocks –The “Ex. Food & Energy” approach –Eckstein (1981) 1990s revival of stochastic approach to index numbers –Selvenathan & Prasada Rao –Bryan & Cecchetti –Quah & Vahey

3. Two new approaches The common component in price changes –Bryan & Cecchetti The persistent component of price changes –Quah & Vahey

4. A basic framework: I

5. A basic framework: II

6. Use of core inflation in monetary policy As a target for monetary policy –Reserve Bank of New Zealand (until 1999), Bank of England, Reserve Bank of Australia (until 1998), Thailand As an input to policy decisions –Fed, ECB As part of communication strategy –Bank of England, Sveriges Riksbank

7. What is the question to which core inflation is the answer? Alternative measure of inflation –Domain of headline measure too broad Answer to a counterfactual –What if? A measure of trend, steady-state or inertial inflation

8. Criteria for evaluating measures of core inflation Computable in real time Forward looking Track record Understandable by the general public History invariant to new data Sound theoretical basis

9. Criterion 1: Computable in real time Essential for use of core inflation –as target –as input to policy –as part of communication Satisfied by almost all popular measures Exceptions: HP, BP, two-sided filters

10. Criterion 2: Forward looking Inherently forward-looking measures –e.g. SVAR measures Measures with predictive power Stable long-run relationship with headline rate

11. Criterion 3: Track record “Ex. Food & Energy” –produced by almost all countries Trimmed mean –most popular of newer measures

12. Criterion 4: Understandable by general public Essential for measure used as target Important if measure used as part of communications strategy Reproducible

13. Criterion 5: History invariant to arrival of new data True of –traditional “Ex. Food & Energy” measures –trimmed mean Problematic for –SVAR, DFI based measures –other model-based measures

14. Criterion 6: Sound basis in economic theory Contrast with theory of cost of living index –well developed & well understood What is the appropriate theory for core inflation? –Quantity theory perspective on inflation –Long run neutrality of money

15. Concluding observations Core inflation a slippery concept –No good theory, yet Tracking trend a useful criterion for discriminating between measures –not without problems