Short-Term Headline-Core Inflation Dynamics
2009; Volume: 95; Issue: 3 Linguagem: Inglês
ISSN
2163-4556
Autores Tópico(s)Economic Theory and Policy
Resumo(ProQuest: ... denotes formulae omitted.) Many analysts contend that the Federal Reserve under ChairmenAlan Greenspan and Ben Bernanke has conducted monetary policy that focuses on core rather than headline inflation. The measure of core inflation used excludes food and energy prices.1 The main argument in favor of using core inflation to implement monetary policy is that core inflation approximates the permanent or trend component of inflation much better than does headline inflation, the latter being influenced more by transitory movements in food and energy prices. The empirical evidence favorable to the use of core inflation in policy is recently reviewed in Mishkin (2007b). This empirical evidence consists of examining short-term dynamics between headline and core inflation measures, indicating that, in samples that start after the early 1980s, headline inflation has reverted more strongly toward core inflation than core inflation has moved toward headline inflation. However, the research reviewed also shows that the evidence indicating the reversion of headline inflation to core inflation is quite weak in samples that start in the 1960s, suggesting that headline-core inflation dynamics may not be stable over time.2 In this article we re-examine the short-term dynamics between headline and core measures of inflation over a longer sample period of 1959-2007. We offer new evidence that headline-core inflation dynamics have indeed changed during this sample period and that this change in dynamics may be due to a change in the conduct of monetary policy in 1979.3 In particular, we examine such dynamics over three sub-periods: 1959:1-1979:1, 1979:2-2001:2, and 1985:1-2007:2. We consider the sub-sample 1985:1-2007:2, as it spans a period of relatively low and stable inflation. We consider both the consumer price index (CPI) and the personal consumption expenditure (PCE) deflator. The data used is biannual because the structural vector autoregression (VAR) model employed uses the Livingston survey data on the public's expectations of headline CPI inflation, which is available twice a year. However, the basic results on the change in short-term headline-core inflation dynamics are robust to using quarterly data and to including additional determinants of inflation in bivariable headline-core inflation regressions. The empirical evidence presented here indicates headline and core measures of inflation are co-integrated, suggesting long-run co-movement. However, the ways these two variables adjust to each other in the short run and generate co-movement have changed across these sub-periods. In the pre- 1979 sample period, when a positive gap opens up with headline inflation rising above core inflation, the gap is eliminated mainly as a result of headline inflation not reverting and core inflation moving toward headline inflation. This result suggests headline inflation is better than core inflation in assessing the permanent component of inflation. In post-1979 sample periods, however, the positive gap is eliminated as a result of headline inflation reverting more strongly toward core inflation than core inflation moving toward headline inflation. This suggests core inflation would be better than headline inflation in assessing the permanent component of inflation. Recent research suggests a monetary policy explanation of this change in short-term headline-core inflation dynamics. We focus on a version of monetary policy explanation suggested by the recentwork of Leduc, Sill, and Stark (2007), which attributes the persistently high inflation of the 1970s to a weak monetary policy response to surprise increases in the public's expectations of inflation. In particular, using a structural VAR that includes a direct survey measure of expected (headline CPI) inflation, Leduc, Sill, and Stark show that prior to 1979, the Federal Reserve accommodated exogenous movements in expected inflation seen in the result that the short-term real interest rate did not increase in response to such movements, which then led to persistent increases in actual inflation. …
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