How Well Does 'Core' Inflation Capture Permanent Price Changes?

CAMA Working Paper 26/2013

41 Pages Posted: 8 Jun 2013

See all articles by Michael D. Bradley

Michael D. Bradley

George Washington University

Dennis W. Jansen

Texas A&M University - Department of Economics

Tara M. Sinclair

George Washington University - Department of Economics; George Washington University - Elliott School of International Affairs (ESIA); George Washington University - Institute For International Economic Policy (GWIIEP); George Washington University - Research Program on Forecasting; George Washington University - George Washington Institute of Public Policy (GWIPP); Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA); Halle Institute for Economic Research

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Date Written: May 1, 2013

Abstract

Does excluding food and energy prices from the Consumer Price Index (CPI) produce a measure that captures permanent price changes? To examine this question we decompose CPI inflation and “core” inflation into their permanent and transitory components using a correlated unobserved components model. One of the key aspects of the correlated unobserved components model is that it allows shocks to the permanent component to potentially be more variable than shocks to the series itself, due to offsetting transitory shocks correlated with the permanent shocks. The stationarity of inflation may be time-varying, so we examine the performance of the core measure of inflation for periods during which it appears that inflation is I(1) and for periods during which it appears that inflation is I(0). For a period in which inflation appears to be I(1), we find that core inflation and the permanent component of overall inflation are closely related, although core inflation does have some drawbacks as a measure of permanent inflation. For a period in which inflation appears to be I(0), we decompose the core and overall price levels and find that the permanent component of core CPI is much more volatile than the actual core series and that core excludes volatile permanent shocks to the overall price level.

Keywords: Consumer Price Index, Inflation, Unobserved Components, Food and Energy Prices

JEL Classification: C32, E31

Suggested Citation

Bradley, Michael D. and Jansen, Dennis W. and Sinclair, Tara M., How Well Does 'Core' Inflation Capture Permanent Price Changes? (May 1, 2013). CAMA Working Paper 26/2013, Available at SSRN: https://ssrn.com/abstract=2275678 or http://dx.doi.org/10.2139/ssrn.2275678

Michael D. Bradley (Contact Author)

George Washington University ( email )

2115 G Street, NW
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Dennis W. Jansen

Texas A&M University - Department of Economics ( email )

5201 University Blvd.
College Station, TX 77843-4228
United States
409-845-7358 (Phone)
409-847-8757 (Fax)

Tara M. Sinclair

George Washington University - Department of Economics ( email )

2115 G Street NW
Monroe Hall Suite 340
Washington, DC 20052
United States
202-944-7988 (Phone)
202-994-6147 (Fax)

HOME PAGE: http://home.gwu.edu/~tsinc/

George Washington University - Elliott School of International Affairs (ESIA) ( email )

2201 G Street, N.W.
Washington, DC 20052
United States
202-994-7988 (Phone)
202-994-6147 (Fax)

HOME PAGE: http://home.gwu.edu/~tsinc/

George Washington University - Institute For International Economic Policy (GWIIEP) ( email )

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Suite 502
Washington, DC 20052
United States

George Washington University - Research Program on Forecasting ( email )

1922 F Street, NW
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Washington, DC 20052
United States

George Washington University - George Washington Institute of Public Policy (GWIPP) ( email )


United States

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA) ( email )

ANU College of Business and Economics
Canberra, Australian Capital Territory 0200
Australia

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
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D-06017 Halle, 06108
Germany

HOME PAGE: http://www.dpe-halle.de/asp/person.asp?xtr&Lang=e

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