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Core Inflation in Brazil

Core Inflation in Brazil. André Minella Tomiê Sugahara Research Department - Banco Central do Brasil VIII Annual Seminar August 2006 Work in Progress – Comments are Welcome. Motivation. Core inflation measures are used in most countries, but… Are core inflation measures really useful?

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Core Inflation in Brazil

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  1. Core Inflation in Brazil André Minella Tomiê Sugahara Research Department - Banco Central do Brasil VIII Annual Seminar August 2006 Work in Progress – Comments are Welcome

  2. Motivation • Core inflation measures are used in most countries, but… • Are core inflation measures really useful? • Do they convey information about “underlying” or future inflation? • How do core measures compare to each other? • Can new measures, such as those based on common factors, be useful? Let’s take a look at what Brazil’s experience says…

  3. Literature • Brazil • Figueiredo (2001), Bryan and Cecchetti (2001) • Pichetti and Toledo (2000), Fiorencio and Moreira (2002), Moreira and Migon (2004), Araújo and Fiorencio (2005) • Gonçalves, Schechtman and Barros (2000) • Other countries • Hogan, Jonhson and Laflèche (2001), Armour (2006) • D’Amato, Sanz and Paladino (2006) • Cristadoro, Forni, Reichlin and Veronese (2005) • Bryan and Cecchetti (1994), Bryan, Cecchetti, and Wiggins II (1997) • Roger (1997, 1998)

  4. Presentation outline • Core measures properties • Core measures for Brazil • Current measures • New measures • Evaluation • Variability • Bias • Capacity to indicate future inflation

  5. Core measures desirable properties • Practical issues • Timely computable • Definite figures (not revisable) • Easily understood by the public • Substantial issues • Reflects “underlying” inflation • Forward-looking nature

  6. Core measures in BrazilIPCA index • By exclusion • Food at home and administered prices are excluded (around 50% of the index) • Trimmed mean (non-smoothed) • 20% of each tail of weighted distribution is excluded • Distribution: Monthly change of IPCA items (47 items up to 1999:7; 52 items 1999:8-2006:6)

  7. IPCA vs. core by exclusion vs. trimmed mean (non smoothed)

  8. Kurtosis – IPCA items

  9. Skewness – IPCA items

  10. IPCA vs. (non-smoothed) trimmed mean using different cutoffs: 20%, 15% and 10%

  11. Core measures in BrazilIPCA index • Smoothed trimmed mean • For 8 items, y-o-y change instead of m-o-m • Asymmetric trimmed mean • Bryan and Cecchetti (2001) • Centered on the 60th percentile of the weighted distribution • 24% cutoff: • 14.4% in the bottom tail • 9.6% in the upper tail

  12. IPCA vs. smoothed trimmed mean vs. asymmetric trimmed mean

  13. Monthly figures

  14. Core measures in BrazilIPCA index • Weighted median • Value of the 50th percentile of the weighted distribution • Double weighted • All items are considered, but they are reweighted according to their volatility: the greater the volatility, the lower the weight

  15. IPCA vs. weighted median vs. double weighted

  16. Core measures in BrazilCore based on common factors • Based onCristadoro, Forni, Reichlin and Veronese (2005), index for the Euro Area • Use information of a large panel of time series • Inflation driven by common factors • Core measure: projection of the medium- and long-run component of monthly inflation on the common factors

  17. Core measures in BrazilCore based on common factors Inflation modeled as: Core measure:

  18. Core measures in BrazilCore based on common factors Panel of 106 series • Prices • Economic activity • Money, credit, and financial variables • Fiscal sector • External sector • International economy

  19. IPCA vs. common-factor-based core measure

  20. Bias and variability

  21. Bias and variability

  22. Forecasting

  23. Cogley’s equation

  24. Cogley’s equation

  25. Conclusions (up to this point) • Core measures: • are less volatile than headline inflation • contain information on future inflation • but some of them are biased downwards • Although results are mixed, Figueiredo’s (2001) result as to the relatively good performance of smoothed trimmed-mean core measure is held • Core based on common factors may be promising, but too early to tell - additional research is warranted

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