Disinflation and Reliability of Underlying Inflation Measures

Abstract

We estimated a Non-Stationary Dynamic Factor model and used it to generate artificial episodes of disinflation (permanent change in the mean inflation rate). These datasets were used to test the performance of alternative underlying inflation measures. We found that the benchmark underlying inflation measures (based on unobserved trend extraction) are more severely affected by disinflation than the alternative simpler methods (based on exclusion or reweighting approaches). Alternatively, a Non-Stationary Dynamic Factor model may be employed for extraction of the unobserved trend to be used as an underlying inflation measure.

Keywords: Underlying inflation, Non-Stationary Dynamic Factor model, Russia

JEL Classification: E31, E32, E52, C32