Inflation%20Measurement%20and%20Monetary%20Policy

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Inflation Measurement and Monetary Policy

• David Lebow
• Federal Reserve Board
• May 13, 2008

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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

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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

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• On whom do the largest costs fall?
• Possible scopes
• HH out of pocket (CPI)
• Full weight of medical, etc. (PCE)
• Businesses and Govts too (GDPur or GDP)
• All transactions (PT MV)
• Environmental factors are in a true COLI

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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)

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• 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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