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Median CPI A Superior Measure When Predicting CPI Inflation

Saturday, April 20, 2013 - 10:17 AM
In 2012, the Federal Open Market Committee (FOMC)'s issued a statement that it would consider raising interest rates when specific thresholds for several economic indicators, such as the unemployment rate and rate of inflation, were met. 

According to research by two economists at the Cleveland Fed, the Federal Reserve should monitor the median consumer price index to forecast inflation because it is a superior measure when predicting CPI inflation.  The measure looks at the median price change, which is the movement for the item that’s in the middle of the distribution of changes for all the goods and services measured. 

The research concludes that:
The use of the median CPI also has other benefits. First, it’s the easiest trimmed mean to conceptualize, as it’s simply the price change in the middle of the distribution. But it also holds an important communications advantage over the oft-used core CPI.

In times when the relative prices of energy and food items are rising rapidly, use of the exclusionary core CPI makes the FOMC appear to be disconnected or insensitive, as it disregards subsistence items that consumers purchase much more frequently than, say, cars or new televisions. In communicating the stance of underlying inflation, hitting the one in the middle is far superior to excluding consumer necessities like food and energy.

In other words, when measuring inflation, target the middle.   Using this measure would address an often-repeated criticism that the FOMC members are out of touch with the real-world inflation that most of us experience at the grocery store and the gas pump. 
pearlbrownpearlbrown1,472 posts since
Nov 2, 2010
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