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Alternative measures of underlying inflation in the euro area

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  • Cristina Conflitti

    (Bank of Italy)

Abstract

This paper proposes two measures of underlying inflation for euro area as an alternative to the Harmonized Index of Consumer Prices excluding Food and Energy. The first measure, called the Core cycle measure, is constructed by using a Phillips curve model to distinguish disaggregated prices that respond to the economic cycle (procyclical), from those which do not (acyclical). The second measure, called the Common core measure, is constructed using a factor model to remove components that are subject to large or unusual price changes, which are unlikely to be related to the underlying trend of inflation because of their idiosyncratic nature. Each measure has merits and shortcomings, suggesting that they should be taken together to assess inflation developments.

Suggested Citation

  • Cristina Conflitti, 2020. "Alternative measures of underlying inflation in the euro area," Questioni di Economia e Finanza (Occasional Papers) 593, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:opques:qef_593_20
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    File URL: https://www.bancaditalia.it/pubblicazioni/qef/2020-0593/QEF_593_20.pdf
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    References listed on IDEAS

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    1. Cristadoro, Riccardo & Forni, Mario & Reichlin, Lucrezia & Veronese, Giovanni, 2005. "A Core Inflation Indicator for the Euro Area," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 539-560, June.
    2. Laurence Ball & Sandeep Mazumder, 2020. "The Nonpuzzling Behavior of Median Inflation," Central Banking, Analysis, and Economic Policies Book Series, in: Gonzalo Castex & Jordi Galí & Diego Saravia (ed.),Changing Inflation Dynamics,Evolving Monetary Policy, edition 1, volume 27, chapter 3, pages 049-070, Central Bank of Chile.
    3. Altissimo, Filippo & Mojon, Benoit & Zaffaroni, Paolo, 2009. "Can aggregation explain the persistence of inflation?," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 231-241, March.
    4. Cristina Conflitti and Matteo Luciani, 2019. "Oil Price Pass-through into Core Inflation," The Energy Journal, International Association for Energy Economics, vol. 0(Number 6).
    5. Alessandro Brunetti, 2010. "The decomposition of the chained price index rate of change: generalization and interpretative effectiveness," Rivista di statistica ufficiale, ISTAT - Italian National Institute of Statistics - (Rome, ITALY), vol. 12(1), pages 17-34, April.
    6. Matteo Luciani & Riccardo Trezzi, 2019. "Comparing Two Measures of Core Inflation: PCE Excluding Food & Energy vs. the Trimmed Mean PCE Index," FEDS Notes 2019-08-02-1, Board of Governors of the Federal Reserve System (U.S.).
    7. Seung C. Ahn & Alex R. Horenstein, 2013. "Eigenvalue Ratio Test for the Number of Factors," Econometrica, Econometric Society, vol. 81(3), pages 1203-1227, May.
    8. Matteo Luciani, 2020. "Common and Idiosyncratic Inflation," Finance and Economics Discussion Series 2020-024, Board of Governors of the Federal Reserve System (U.S.).
    9. Ricardo Reis & Mark W. Watson, 2010. "Relative Goods' Prices, Pure Inflation, and the Phillips Correlation," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(3), pages 128-157, July.
    10. Stock J.H. & Watson M.W., 2002. "Forecasting Using Principal Components From a Large Number of Predictors," Journal of the American Statistical Association, American Statistical Association, vol. 97, pages 1167-1179, December.
    11. Rostagno, Massimo & Altavilla, Carlo & Carboni, Giacomo & Lemke, Wolfgang & Motto, Roberto & Saint Guilhem, Arthur & Yiangou, Jonathan, 2019. "A tale of two decades: the ECB’s monetary policy at 20," Working Paper Series 2346, European Central Bank.
    12. Jushan Bai, 2003. "Inferential Theory for Factor Models of Large Dimensions," Econometrica, Econometric Society, vol. 71(1), pages 135-171, January.
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    Citations

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    Cited by:

    1. Stefano Neri & Fabio Busetti & Cristina Conflitti & Francesco Corsello & Davide Delle Monache & Alex Tagliabracci, 2023. "Energy price shocks and inflation in the euro area," Questioni di Economia e Finanza (Occasional Papers) 792, Bank of Italy, Economic Research and International Relations Area.
    2. Carlomagno, Guillermo & Fornero, Jorge & Sansone, Andrés, 2023. "A proposal for constructing and evaluating core inflation measures," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 4(3).
    3. Guillermo Carlomagno & Jorge Fornero & Andrés Sansone, 2021. "Toward a general framework for constructing and evaluating core inflation measures," Working Papers Central Bank of Chile 913, Central Bank of Chile.
    4. Sara Serra & João Quelhas, 2023. "The inflation process in Portugal: the role of price spillovers," Economic Bulletin and Financial Stability Report Articles and Banco de Portugal Economic Studies, Banco de Portugal, Economics and Research Department.

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    More about this item

    Keywords

    core inflation; disaggregate consumer prices; dynamic factor model; Phillips curve;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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