Testing for Explosive Behaviour in Relative Inflation Measures: Implications for Monetary Policy

Vipin Arora (), Pedro Gomis-Porqueras and Shuping Shi

No 37-11, Monash Economics Working Papers from Monash University, Department of Economics

Abstract: In this paper we test for large deviations in headline measures of the price level relative to core measures using the recently proposed test of Phillips et al. (2011a). We find evidence of explosive behaviour in the headline price index of personal consumption expenditures (PCE) relative to the core PCE (less food and energy prices) on three occasions from 1982-2010. Two of these episodes correspond to energy supply shocks (OPEC price collapse of 1986 and Hurricane Katrina). The third one is during March 2008 through September 2008 which seems to be driven by both food and energy prices as these indices exhibit explosive behaviour. We also find evidence suggesting that inflation expectations behave differently under normal and explosive periods. In particular, unemployment and interest rates also help predict inflation expectations during explosive episodes relative to normal times. Furthermore, explosive episodes in the relative measure between headline and core inflation is found to be more important than the relative volatile periods implied by a Markov-switching model when studying inflation expectations. The findings of this paper suggest that explosive behaviour of headline versus core PCE should be taken into account when conducting monetary policy as it is a key determinant in consumers’ inflation expectations.

Keywords: Explosive behaviour; core inflation; relative measure; inflation expectations (search for similar items in EconPapers)
JEL-codes: C5 E31 (search for similar items in EconPapers)
Pages: 14 pages
Date: 2011-12
New Economics Papers: this item is included in nep-agr, nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: The divergence between core and headline inflation: Implications for consumers’ inflation expectations (2013)
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