Core inflation as a predictor of total inflation

Inflation (Finance) ; Economic indicators

Core measures of inflation as predictors of total inflation

Two rationales offered for policymakers' focus on core measures of inflation as a guide to underlying inflation are that core inflation omits food and energy prices, which are thought to be more volatile than other components, and that core inflation is thought to be a better predictor of total inflation over time horizons of import to policymakers. The authors' investigation finds little support for either rationale. They find that food and energy prices are not the most volatile components of inflation and that depending on which inflation measure is used, core inflation is not necessarily the best predictor of total inflation. However, they do find that combining CPI and PCE inflation measures can lead to statistically significant more accurate forecasts of each inflation measure, suggesting that each measure includes independent information that can be exploited to yield better forecasts.Inflation (Finance)

Core measures of inflation as predictors of total inflation

Policymakers tend to focus on core inflation measures because they are thought to be better predictors of total inflation over time horizons of import to policymakers. The authors find little support for this assumption. While some measures of core inflation are less volatile than total inflation, core inflation is not necessarily the best predictor of total inflation. The relative forecasting performance of models using core inflation and those using only total inflation depends on the inflation measure and time horizon of the forecast. Unlike previous studies, the authors provide a measure of the statistical significance of the difference in forecast errors. ; Supersedes Working Paper 08-9.Inflation (Finance)

Core Inflation as a Predictor of Total Inflation 1

This is the first Research Rap – Special Report. This occasional publication will present new research by staff members of the Federal Reserve Bank of Philadelphia’s Research Department. Regular editions of Research Rap will continue to present abstracts of staff members ’ working papers