Abstract
The recent volatile behaviour of U.K. inflation has been officially attributed to a sequence of “unusual” price changes, prompting renewed interest in the construction of measures of “core inflation”, from which such unusual price changes may be down-weighted or even excluded. This paper proposes a new approach to constructing core inflation based on detailed analysis of the temporal stochastic structure of the individual prices underlying a particular index. This approach is illustrated using the section structure of the U.K. retail price index (RPI), providing a number of measures of core inflation that can be automatically calculated and updated to provide both a current assessment and forecasts of the underlying inflation rate in the U.K.
Highlights
The behaviour of inflation in the U.K. since 2007, and after the “credit crunch” of 2008, has been extremely volatile
The Monetary Policy Committee (MPC)’s central judgement remains that these effects will prove to have a temporary impact on inflation” (August 2010); “the current elevated rate of inflation largely reflects a number of temporary influences” (November 2010); and “three factors can account for the current high level of inflation: the rise in VAT relative to a year ago, the continuing consequences of the fall in sterling in late 2007 and 2008, and recent increases in commodity prices, energy prices
To make this set-up operational clearly requires estimates of the trend components of the prices. We suggest that such estimates are obtained using the following procedure, which is based on a refinement of the unobserved component (UC) representation to xi,t i,t i,t i,t i,t j 1 j I j,t
Summary
The behaviour of inflation in the U.K. since 2007, and after the “credit crunch” of 2008, has been extremely volatile. An approach that was popular during the second half of the 1990s may be termed the economic theory or modelbased approach, its most notable proponents being Quah and Vahey, who defined core inflation to be the component of measured inflation that has no medium to long-run impact on real output, motivating this definition by the assumption of a vertical long-run Phillips curve [7]. Their measure is constructed by placing long-run coefficient restrictions on a bivariate non-cointegrated vector autoregressive VAR system for output and inflation.
Sign-in/Register to view highlights & summary Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
