# A Comparison of Measures of Core Inflation

Abstract: The ability of central banks to differentiate between permanent and transitory price movements is critical for the conduct of monetary policy. The importance of gauging the persistence of price changes in a timely manner has led to the development of measures of underlying, or core, inflation that are designed to remove transitory price changes from aggregate inflation data. Given the usefulness of this information to policymakers, there is a surprising lack of consensus on a preferred measure of U.S. core inflation. This article examines several proposed measures of core inflation - the popular ex food and energy series, an ex energy series, a weighted median series, and an exponentially smoothed series - to identify a best measure. The authors evaluate the measures' performance according to criteria such as ease of design and accuracy in tracking trend inflation, as well as explanatory content for within-sample and out-of-sample movements in aggregate CPI and PCE inflation. The study reveals that the candidate series perform very differently across aggregate inflation measures, criteria, and sample periods. The authors therefore find no compelling evidence to focus on one particular measure of core inflation, including the series that excludes food and energy prices. They attribute their results to the design of the individual measures and the measures' inability to account for variability in the nature and sources of transitory price movements.

## Summary (2 min read)

### 1. Introduction

- Entral banks differ in their specific inflation objectives and conduct of policy.
- Because of the lagged effects of monetary policy, mistaking the nature of price changes can be extremely costly.
- The lack of consensus on a preferred measure of core inflation might seem surprising given the importance of this information to policymakers.
- To evaluate the core measures of inflation, the authors select criteria that have been used in previous studies: ease of design, a similar mean to the goal inflation series, and an ability to track the trend in the goal inflation series.

### 2. Motivation and Concepts

- Almost all central banks are concerned with, and have some mandate to achieve, price stability.
- One reason for this linkage is that the prices for many capital goods purchased by businesses are extremely difficult to measure,1 as are those for many products provided by governments (such as public education).
- Another reason why a central bank would be concerned with movements in a household or consumer price measure is that many formal escalation arrangements, notably for wages as well as taxes and government benefits, are connected to indexes of consumer prices.
- The more familiar measure of core inflation as aggregate price growth excluding food and energy appears to have been analyzed first in a systematic fashion in a paper by Gordon (1975b).
- 5Some researchers (Aoki 2001; Benigno 2004; Goodfriend and King 1997) have argued that the appropriate goal for monetary policy should be set in terms of a measure of “core” inflation.

### 3. Core Inflation: Proposed Measures and Evaluation

- Alternative measures of core inflation have been proposed.
- This development likely reflects the lack of a widely accepted definition of core inflation.
- Some of these measures associate the bulk of transitory price fluctuations with specific components, thereby prompting their exclusion from an aggregate price index.
- In their view, any evaluation of a trimmed mean measure should be undertaken using recursive estimation so that the trimmed mean is constructed sequentially.
- Clark (2001) judges core inflation measures based on their complexity, similarity of means, ability to track a measure of the trend rate of inflation, and within-sample predictive content (criteria 1, 2, 3, and part of criterion 4).

### It is important to note . . . that in the

- Literature there has been little uniformity in the criteria used to evaluate core measures of inflation.
- There is one additional point that merits attention, given the conflicting evidence reported in previous studies.
- It is important to note that these views reflect not only an explicit statement about the sources of transitory price movements, but also an implicit assumption concerning the invariance of these sources.
- If the pattern of transitory price movements were to change over time, then the reliability of core inflation measures would likely be affected.
- Keeping these considerations in mind, the authors now turn to the empirical framework.

### 4. Empirical Framework

- For the analysis, the authors restrict their attention to aggregate inflation measures that would likely be of interest to policymakers and the public.
- The authors select two measures: quarterly growth in the PCE index and quarterly growth in the methodologically consistent CPI.
- To gauge the accuracy with which core inflation tracks trend inflation, the authors follow Clark (2001) and use a measure of volatility for this assessment.
- For the within-sample analysis, the authors undertake the estimation of equation 3, using all available observations over a sample period and allowing the values of h to range from one to twelve quarters.
- As a second point, the authors recognize that there may be caveats associated with some of the statistical criteria used to evaluate the candidate core inflation series.

### 5. Empirical Results

- The data on the candidate core measures for PCE inflation start in 1959:2.
- For both the weighted median series and the exponentially smoothed PCE, the means of the core inflation measures are somewhat higher than those of the respective aggregate inflation series.
- The Diebold-Mariano (1995) test statistic considers the null hypothesis of equal root mean squared error (RMSE) against the alternative hypothesis that the RMSE of a relevant benchmark series is lower, also known as Notes.
- In the case of the forecasts for the post-1995 period, the core inflation measure associated with the lowest RMSE varied from the ex energy series (four-quarter horizon) to the exponentially smoothed series (eight-quarter horizon) to the ex food and energy series (twelve-quarter horizon).
- When there is evidence indicating that a core inflation measure may be well suited for performing a particular task, the same measure often displays inferior performance in terms of other criteria.

### 6. Conclusion

- Viewing the stabilization of CPI or PCE inflation as plausible goals for U.S. monetary policy, the authors evaluate several proposed measures of “core” inflation.
- Rather, the authors documented considerable variation in the performance of the candidate series.
- Another possibility is to acknowledge that different core inflation measures seem better suited to performing different tasks, and then adopt the appropriate core inflation measure as the guide for a particular stated purpose.
- “An Alternative Measure of Core Inflation.” Federal Reserve Bank of Chicago Economic Perspectives 30, first quarter: 55-65.

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### "A Comparison of Measures of Core In..." refers background in this paper

...5Some researchers (Aoki 2001; Benigno 2004; Goodfriend and King 1997) have argued that the appropriate goal for monetary policy should be set in terms of a measure of “core” inflation....

[...]

716 citations

### "A Comparison of Measures of Core In..." refers background in this paper

...In addition to these four series, Rich and Steindel (2005) examine exponentially smoothed versions of the ex food and energy, ex energy, and weighted median series as candidate core inflation measures....

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