Why the Median Inflation Gauge May Be a Better Measure of Price Rise
- The Cleveland Fed has developed a median measure, which shows the item in the middle of the range of all price changes each month.
- Even before the pandemic, research found these measures to be less volatile than traditional core inflation and more closely tied to the economic downturn.
- Similar findings led the Bank of Canada to adopt a weighted median and a trimmed mean as primary measures of core inflation in 2016, replacing their traditional core measure.
Economists debating inflation in the United States face a difficult challenge: weeding out volatile price changes to assess the underlying pressures.
The most common measure of underlying or “core” inflation, which excludes food and energy price volatility, has been difficult to read during the pandemic. The traditional measure was widely used in the 1970s, when volatile energy prices caused spikes in inflation.
Our research shows that for most of the past two years, the traditional core measure has been almost as volatile as headline inflation, as many significant price changes have occurred in sectors other than food and energy. Examples include airlines, hotels, sporting events and financial services.
In our view, the measures that best filter out transients are the outlier exclusion measures. Two of these gauges developed by regional Federal Reserve banks in Cleveland and Dallas omit large price changes in any industry, and they work better than gauges that rule out a fixed set of additional industries, such as the Atlanta Fed’s consumer price index at fixed prices.
The Cleveland Fed has developed a median measure, which shows the item in the middle of the range of all price changes each month, while the Bank of Dallas has an adjusted mean methodology which omits items in the bottom 24% and the top 31% of circulation each month. Although slightly different, the two filter out most of the monthly swings in headline inflation and have been relatively stable.
They’re also more closely tied to unemployment and other indicators of economic downturns than headline inflation or the traditional core measure, falling as the economy contracted in 2020 and then rising as the economy rebounded.
These alternative indicators of underlying inflation have steadily increased in 2021, confirming that underlying inflation trends in the United States have increased.
Just a wink?
Even before the pandemic, research found these measures to be less volatile than traditional core inflation and more closely tied to the economic downturn.
In the three decades before the pandemic, the basic measures that eliminate a greater share of outlier price movements were more stable and had a more reliable relationship with unemployment. Inflation excluding food and energy was more volatile than median and average inflation and had a much weaker relationship with macroeconomic conditions.
Similar findings led the Bank of Canada to adopt a weighted median and a trimmed mean as primary measures of core inflation in 2016, replacing their traditional core measure.
Overall, we find that the case for the Fed to move away from the traditional measure of underlying inflation has strengthened in 2020-21.
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