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Measuring Underlying Inflation Using Dynamic Model Averaging

June 29, 2016
Yuto Iwasaki*1
Sohei Kaihatsu*2

Abstract

This paper presents a new framework for measuring underlying inflation with multiple core indicators for Japan's consumer price index (CPI). Specifically, a combined core indicator is constructed by applying an econometric method based on dynamic model averaging as a weighted average of individual core indicators. The combined core indicator has time-varying combination weights reflecting changes in the predictive performance of each individual core indicator on a real time basis. Thus, the combined core indicator has the potential to adapt to changes in the nature and sources of price movements. Empirical evidence indicates that the combined core indicator firmly outperforms the individual core indicators over time. In addition, the combination weights for the exclusion-based indicators (e.g., the CPI excluding fresh food) tend to be high when aggregate shocks drive the overall inflation. In contrast, combination weights for the distribution-based indicators (e.g., trimmed mean) tend to be high when idiosyncratic shocks are dominant.

JEL Classification
C52, C53, E31

Keywords
Consumer price; Core inflation measure; Dynamic model averaging

We would like to thank the staff of the Bank of Japan for their helpful comments. The views expressed here, as well as any remaining errors, are those of the authors and should not be ascribed to the Bank of Japan.

  1. *1Monetary Affairs Department, Bank of Japan
    E-mail : yuuto.iwasaki@boj.or.jp
  2. *2Monetary Affairs Department (currently Research and Statistics Department), Bank of Japan
    E-mail : souhei.kaihatsu@boj.or.jp

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