CORE INFLATION IN PERU: MEASUREMENT OPTIONS

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CORE INFLATION IN PERU MEASUREMENT OPTIONS

• 1995 -2000

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Definition of Core Inflation

• Price indicator free of transitory shocks,
  inflation component that depends on macroeconomic
  fundamentals.
• This indicator should allow the ex-post
  evaluation of monetary policy by the public and
  constitute an operative goal for monetary policy
  makers.

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Properties of a Good Core Inflation Indicator

• It should not overestimate or underestimate
  inflation in the long run
• Variability lower than that of inflation
• Easy to understand by the public
• Stable in time
• Quick availability

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Core Inflation Estimation Methods

• Trend methods
• Re-weighting of prices according to their
  volatility
• Econometric models
• VAR error correction model

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Core Inflation Estimation Methods

• Median (50th percentile) Distribution of price
  changes is skewed. Median underestimates
  inflation. Cumulative variation of median
  1995-2000 33,7 (versus 49,7 of CPI).
• The percentile 59 contains the arithmetic mean
  most times between 1995 and 2000. Cumulative
  variation 1995-2000 46,2. Volatility 50 lower
  than CPI volatility.
• Disadvantage The selected percentile changes in
  time. It changed from 61 in 1999 to 59 in 2000.

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Core Inflation Estimation Methods

• Exclusion of 15 and 20 of items with higher
  volatility in their monthly changes.
• Exclusion of items with higher volatility in
  their weighted contributions to inflation
  chicken, potato, onion, bread, urban
  transportation, fish, eggs, citrus fruits and
  vegetables.
• Ad-hoc exclusion of items non-tradable food,
  fuel and urban transportation.

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Selected Core Inflation Indicators

• Option 1 CPI excluding items with higher
  volatility in their weighted contributions to
  inflation chicken, potato, onion, bread, urban
  transportation, fish, eggs, citrus fruits and
  vegetables.
• Option 2 Option 1 excluding fuel.
• Option 3 CPI excluding non-tradable food, fuel
  and urban transportation.

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Inflation and Core Inflation (Year to year
variations)
CPI Opt.1 Var 95-00
49,7 52,1 Std. dev. 0,44
0,32
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Inflation and Core Inflation (Year to year
variations)
CPI Opt.2 Var 95-00
49,7 50,1 Std. dev. 0,44
0,35
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Inflation and Core Inflation (Year to year
variations)
CPI Opt.3 Var 95-00
49,7 52,3 Std. dev. 0,44
0,31
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Conclusions

• All three measures meet the general properties of
  a good core inflation indicator.
• Option 3 filters recent supply shocks best.
• Option 2 mixes two different criteria by
  excluding from the CPI the items with higher
  volatility in their weighted contributions to
  inflation and also excluding fuel prices, that do
  not appear in that list.
• Option 3 was chosen as the core inflation measure.