Discussions of the goals of monetary policy
generally focus on the benefits of stabilizing prices. However,
measuring the general level of prices is difficult, as nonmonetary
events can, at least temporarily, distort reported inflation
statistics, such as the Consumer Price Index (CPI). During
periods of bad weather, for example, food prices may rise
to reflect decreased supply, producing transitory increases
in the CPI. But since these prices do not constitute monetary
inflation, monetary policymakers may want to avoid including
them in their decisionmaking.
One commonly used technique for measuring underlying
or core inflation is to exclude certain prices in the computation
of the index, based on the assumption that these prices are
the ones with "high-noise" components. This is the
rationale behind the commonly reported CPI excluding food
and energy data. However, economists Michael Bryan and Stephen
Cecchetti have found a measure that forecasts inflation better
than either the CPI excluding food and energy or the all items
CPI: a weighted median of the CPI.
The weighted median CPI is easy to calculate
and has a higher correlation with past money growth than other
inflation measures, resulting in improved forecasts of future
inflation. Bryan and Cecchetti believe the weighted median
CPI can be a useful and timely guide for inflation policy.
F. Bryan is an economist and assistant vice president
at the Federal Reserve Bank of Cleveland. Stephen G. Cecchetti
is an economics professor at Ohio State University and an
associate of the National Bureau of Economic Research.