CORE INFLATION IN PERU: MEASUREMENT OPTIONS

1995 -2000

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.

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

Core Inflation Estimation Methods

• Trend methods

• Re-weighting of prices according to their volatility

• Econometric models

– VAR error correction model

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.

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.

Alternative Core Inflation Measures

1995-2000

CPI Kernel Median Perc. 59 Model Excluding Excluding Excl. higher Ad-hoc

15% 20% w eighted Exclusion

contrib.

1995 10.2 10.8 6.5 9.1 8.0 10.7 10.6 10.4 11.0

1996 11.8 10.9 7.8 9.0 5.8 11.2 11.2 9.9 9.7

1997 6.5 7.5 4.7 6.4 4.8 6.5 6.7 7.8 7.4

1998 6.0 5.4 4.6 6.0 4.3 6.9 6.5 6.8 7.8

1999 3.7 3.7 3.9 5.2 4.0 5.2 5.5 4.6 4.6

2000 3.7 3.8 2.5 3.5 3.9 4.3 4.0 4.0 3.2

Var% 95-00 49.7 49.7 33.7 46.2 34.8 53.8 53.4 52.1 52.3

Std. Dev. 0.44 0.27 0.20 0.23 0.12 0.30 0.30 0.32 0.31

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.

Inflation and Core Inflation (Year to year variations)

2

4

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16

18

ene-95 jul-95 ene-96 jul-96 ene-97 jul-97 ene-98 jul-98 ene-99 jul-99 ene-00 jul-00

CPI Option 1

CPI Opt.1

Var% 95-00: 49,7 52,1

Std. dev.: 0,44 0,32

Inflation and Core Inflation (Year to year variations)

2

4

6

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18

20

ene-95 jul-95 ene-96 jul-96 ene-97 jul-97 ene-98 jul-98 ene-99 jul-99 ene-00 jul-00

CPI Opción 2

CPI Opt.2

Var% 95-00: 49,7 50,1

Std. dev.: 0,44 0,35

Inflation and Core Inflation (Year to year variations)

2

4

6

8

10

12

14

16

18

20

ene-95 jul-95 ene-96 jul-96 ene-97 jul-97 ene-98 jul-98 ene-99 jul-99 ene-00 jul-00

CPI Opción 3

CPI Opt.3

Var% 95-00: 49,7 52,3

Std. dev.: 0,44 0,31

Inlation and core inflation

Year to year variations

CPI Option 1 Option 2 Option 3

Excluded % 0.0% 21.2% 24.5% 30.3%

Var% 95-00 49.7 52.1 50.1 52.4

Std. Dev. 95-00 0.44 0.32 0.35 0.31

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.