Monetary Policy and the Measurement of Inflation: Prices, Wages and Expectations

395 Pages Posted: 3 Feb 2010

See all articles by Stephen G. Cecchetti

Stephen G. Cecchetti

National Bureau of Economic Research (NBER); Brandeis International Business School; Centre for Economic Policy Research (CEPR); European Systemic Risk Board

Ramon Moreno

Self employed

Dubravko Mihaljek

Bank for International Settlements (BIS) - Monetary and Economic Department

Agustin Villar

Bank for International Settlements (BIS)

Sweta C. Saxena

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: January 1, 2010

Abstract

Issues of inflation measurement are fundamental to the conduct of monetary policy. Price indices form the foundation of central bank policy frameworks around the world. They serve as guides to decision-making, as well as providing the primary mechanism for holding independent policymakers accountable. To shed some light on the role of inflation measurement, the annual meeting of Deputy Governors of emerging market economies (EMEs), held in Basel on 5-6 February 2009, explored three issues: Price indices used by central banks; the role of wages and productivity in inflation policy; and the measurement and assessment of inflation expectations. This volume contains contributions by senior central bankers and BIS staff. The issues are summarised in an overview chapter by Stephen Cecchetti.

Price indices used by central banks. The primary price indicator or target of EME central banks is headline CPI, supplemented by other indicators. At least two issues of measurement arise. The first is transitory phenomena, or noise, that should not affect policymakers' actions. Many central banks deal with noise by using measures of underlying or core inflation that exclude certain prices from computation in the index. The second issue is measurement biases, related to the way in which individual prices are weighted together to form an aggregate index (weighting bias; eg substitution bias); or due to actual errors in measuring the individual prices themselves (eg quality or new goods bias).

Wages, productivity and structural inflation. Wages are a key element in the inflation process: Wage growth equals productivity growth plus inflation and real wage growth that is in line with labour productivity growth is widely seen as a precondition for macroeconomic stability. In EMEs, a close relationship between real wage growth and labour productivity growth helps preserve external competitiveness while limiting inflationary pressures and the risk of a wage-price spiral developing. The adoption of inflation targeting frameworks by many emerging market central banks has provided an incentive to compile better labour market data and has enabled central banks to use productivity and unit labour costs more widely in their inflation forecasts. Other aspects of the role of wages in inflation are highlighted by two-sector models of differential productivity growth in tradable and non-tradable industries. One implication is that the rate of wage increase will depend on wage increase in the tradable sector. Another is that inflation sometimes reflect productivity growth in tradable industries, so not all inflation in rapidly-growing EMEs is necessarily undesirable or avoidable.

Inflation expectations and monetary policy. Three issues may be highlighted that are discussed in this volume drawing on EME experience: (i) How central banks measure inflation expectations and use such measures; (ii) the relationship between inflation expectations and the costs of disinflation; and (iii) whether monetary policy frameworks are effective in anchoring inflation expectations. Measurements of expectations draw either on surveys (of households and businesses, professional forecasters and financial market participants) or financial markets (eg the difference in return between an inflation-linked bond and a nominal rate). As for the costs of disinflation, these are related to inflation persistence, which can in turn be related to expectations (eg backward-looking, or reflecting limited information about central bank objectives). Finally, the experience of central banks suggests that inflation expectations have been better anchored in this decade.

JEL Classification: E30, E31, E37, E39, E52

Suggested Citation

Cecchetti, Stephen G. and Cecchetti, Stephen G. and Moreno, Ramon and Mihaljek, Dubravko and Villar, Agustin and Saxena, Sweta Chaman, Monetary Policy and the Measurement of Inflation: Prices, Wages and Expectations (January 1, 2010). BIS Paper No. 49, Available at SSRN: https://ssrn.com/abstract=1546992

Stephen G. Cecchetti (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
212-720-8629 (Phone)
212-720-2630 (Fax)

Brandeis International Business School ( email )

415 South Street
Waltham, MA 02453
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Systemic Risk Board ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Ramon Moreno

Self employed ( email )

Basel
Switzerland

Dubravko Mihaljek

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Agustin Villar

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Sweta Chaman Saxena

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
722
Abstract Views
3,440
Rank
65,583
PlumX Metrics