Asset Prices in the Measurement of Inflation

40 Pages Posted: 10 Jan 2002 Last revised: 24 Mar 2010

See all articles by Michael F. Bryan

Michael F. Bryan

Federal Reserve Bank of Cleveland; Federal Reserve Banks - Federal Reserve Bank of Atlanta

Stephen G. Cecchetti

Brandeis International Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Roisin O'Sullivan

Smith College - Department of Economics

Date Written: January 2002

Abstract

The debate over including asset prices in the construction of an inflation statistic has attracted renewed attention in recent years. Virtually all of this (and earlier) work on incorporating asset prices into an aggregate price statistic has been motivated by a presumed, but unidentified transmission mechanism through which asset prices are leading indicators of inflation at the retail level. In this paper, we take an alternative, longer-term perspective on the issue and argue that the exclusion of asset prices introduces an 'excluded goods bias' in the computation of the inflation statistic that is of interest to the monetary authority. We implement this idea using a relatively modern statistical technique, a dynamic factor index. This statistical algorithm allows us to see through the excessively 'noisy' asset price data that have frustrated earlier researchers who have attempted to integrate these prices into an aggregate measure. We find that the failure to include asset prices in the aggregate price statistic has introduced a downward bias in the U.S. Consumer Price Index on the order of magnitude of roughly 1/4 percentage point annually. Of the three broad assets categories considered here -- equities, bonds, and houses -- we find that the failure to include housing prices resulted in the largest potential measurement error. This conclusion is also supported by a cursory look at some cross-country evidence.

Suggested Citation

Bryan, Michael F. and Cecchetti, Stephen G. and O'Sullivan, Roisin, Asset Prices in the Measurement of Inflation (January 2002). NBER Working Paper No. w8700. Available at SSRN: https://ssrn.com/abstract=296544

Michael F. Bryan

Federal Reserve Bank of Cleveland ( email )

PO Box 6387
Cleveland, OH 44101
United States

Federal Reserve Banks - Federal Reserve Bank of Atlanta

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

Stephen G. Cecchetti (Contact Author)

Brandeis International Business School ( email )

415 South Street
Waltham, MA 02453
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
212-720-8629 (Phone)
212-720-2630 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Roisin O'Sullivan

Smith College - Department of Economics ( email )

Northampton, MA 01063
United States

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