Working Papers, Department of Economics, Lund University
Fredrik N. G. Andersson
Core Inflation - Why the Federal Reserve Got it Wrong
Abstract: This paper introduces a new estimate of core inflation.
Core inflation is a real time estimate of monetary inflation. Most existing
core inflation estimate do not account for persistent relative price
changes and are therefore likely to be poor estimates of the underlying
monetary inflation rate. The proposed core inflation estimate estimates
core inflation by first estimating the inflation signal in all price series
from the price index with a wavelet based signal estimation algorithm. In
the second step the weighted inflation average is calculated by using the
expenditure weights from the price index as weights. Relative price changes
are thus accounted for under the assumption that the household must apply
to its long run budget restriction. The proposed estimate of core inflation
is estimated using data from the United States and the United Kingdom. It
is evaluated by comparing it to existing estimates of core inflation. The
empirical analysis show that the proposed estimate has a smaller
forecasting error of future inflation than the other estimates and that it
rapidly responds to increases in monetary inflation.
Keywords: Core Inflation; Signal Estimation; Wavelets; (follow links to similar papers)
JEL-Codes: E31; E52; (follow links to similar papers)
46 pages, December 2, 2008
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