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Inflation Measurement and Monetary Policy
David Lebow
Federal Reserve Board
May 13, 2008
Central banks use inflation for different purposes
• Internal analysis and forecasting– No single measure best– Core inflation useful
• Public communication– Clarity and simplicity are virtues
• So stick to one price measure
– Overall inflation important
Under-studied topic: Scope
• What price measure should a central bank most want to stabilize? Must it be a consumer price?
• Depends on perceived cost of inflation– New Keynesian literature: relative price
variability affects resource allocation– Fischer-Modigliani (25 direct effects plus 25
indirect effects)– Money illusion and long-term planning
• On whom do the largest costs fall?
• Possible scopes– HH out of pocket (CPI)– Full weight of medical, etc. (PCE)– Businesses and Gov’ts too (GDPur or GDP)– All transactions (PT = MV)– “Environmental” factors are in a true COLI
This can matter quantitatively• Not included in studies of measurement
error– Implicitly take scope as correct
• Example 1: Medical prices– Full weight in CPI: raise weight by factor of
four, would boost CPI about .25 pp per year– Same order of magnitude as other well known
categories of bias (but opposite sign)
• Example 2: European HICPs– Omit owner-occupied housing– Owner-occupancy shares (2002):
• Spain 85%• Italy 80%• Denmark 51%• Germany 42%
– “Harmonize” methodology by de-harmonizing scope
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