Median CPI Provides More Accurate Inflation Forecasts, Says a Recent Study by Cleveland Fed Researchers

The median CPI was more accurate in forecasting inflation than the oft-cited headline CPI or core CPI, say researchers at the Federal Reserve Bank of Cleveland, which calculates the measure. In a study released today by the Bank, the researchers also discuss several other advantages that the median CPI provides to policymakers and economic analysts who measure, forecast, and communicate about inflation.

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The median CPI was more accurate in forecasting inflation than were the oft-cited headline CPI or the core CPI. It is also more likely to act as an early warning system in the event inflation starts to pick up.

Cleveland, OH (PRWEB) April 11, 2013

In statistical tests done by Cleveland Fed researchers Brent Meyer, Guhan Venkatu, and Saeed Zaman, the median CPI was more accurate in forecasting inflation 12 or 24 months ahead than were the oft-cited headline CPI or the core CPI (CPI less food and energy).

In addition, the median CPI:

--Is more likely to act as an early warning system in the event that inflation starts to pick up, as it more quickly sheds relative-price “noise.”

--Is useful in forecasting both headline and core PCE inflation. As the researchers note, the Federal Reserve’s two percent inflation objective is expressed in terms of changes in the Personal Consumption Expenditures (PCE) price index.

--Has an important communications advantage. When the relative prices of energy and food items are rising rapidly, expressing inflation in terms of the core CPI -- which excludes volatile food and energy prices – can make policymakers and economic analysts appear to be disconnected or insensitive, as the measure excludes two subsistence items that consumers purchase frequently.

--Is relatively simple to calculate. The CPI tracks changes in the prices of selected consumer goods and services. The median CPI is derived by ranking those price changes from the lowest to the highest, and using only the price change in the middle.

Read Forecasting Inflation? Target the Middle.

Track the Median CPI or subscribe to monthly updates.

In another Cleveland Fed study released today, vice president and economist Joseph Haubrich analyzed several factors that affect the level of interest rates to find out why nominal rates are so low. He found that a lower real interest rate accounts for the bulk of the decrease in nominal rates.

He also found that:

--Expected inflation has fallen

--The risk premium for inflation has remained fairly steady

--There has been no dramatic falling off in the term premium.

Read Why Are Interest Rates So Low?

Track the Cleveland Fed’s estimates of inflation expectations or subscribe to monthly updates.


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