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Using the First Principal Component as a Core Inflation Indicator

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Abstract

This paper investigates the consequences of non-stationarity for the principal components analysis and suggests a data transformation that allows obtaining smoother series for the first principal component to be used as a core inflation indicator. The paper also introduces a theoretical model, which allows interpreting core inflation as a common stochastic trend to the year-on-year rates of change of the price indices of the basic CPI items. Finally, it is shown that the first principal component computed in real time meets the evaluation criteria introduced in Marques et al. (2000).

Suggested Citation

  • José Ferreira Machado, 2001. "Using the First Principal Component as a Core Inflation Indicator," Working Papers w200109, Banco de Portugal, Economics and Research Department.
    • Handle: RePEc:ptu:wpaper:w200109
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    File URL: https://www.bportugal.pt/sites/default/files/anexos/papers/wp200109.pdf
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    Cited by:

    1. Ivan Roberts, 2005. "Underlying Inflation: Concepts, Measurement and Performance," RBA Research Discussion Papers rdp2005-05, Reserve Bank of Australia.
    2. Fröhling, Annette & Lommatzsch, Kirsten, 2011. "Output sensitivity of inflation in the euro area: Indirect evidence from disaggregated consumer prices," Discussion Paper Series 1: Economic Studies 2011,25, Deutsche Bundesbank.
    3. Bańbura, Marta & Bobeica, Elena, 2020. "PCCI – a data-rich measure of underlying inflation in the euro area," Statistics Paper Series 38, European Central Bank.
    4. Frank Leung & Kevin Chow & Simon Chan, 2010. "Measures of trend inflation in Hong Kong," BIS Papers chapters, in: Bank for International Settlements (ed.), Monetary policy and the measurement of inflation: prices, wages and expectations, volume 49, pages 177-200, Bank for International Settlements.
    5. Mick Silver, 2006. "Core Inflation Measures and Statistical Issues in Choosing Among Them," IMF Working Papers 2006/097, International Monetary Fund.

    More about this item

    JEL classification:

    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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