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Revised model improves core inflation clarity

Core inflation is a concept of price inflation that excludes one-off or highly volatile price movements.

Central Banks use core inflation measures to assess the factors relating to underlying inflation. This is useful because idiosyncratic price movements, such as specific large changes in individual product prices, alter headline CPI inflation but do not necessarily reflect fundamental or persistent sources of inflation pressures.

Measuring inflation

There are many ways to measure core inflation.

Statistics New Zealand publishes a range of measures that involve removing volatile price movements before inflation is calculated, or excluding certain groups of items from the calculation.

Reserve Bank of New Zealand (RBNZ) has a set of models that produce core inflation estimates. Every model is different, and the Bank uses the full suite of measures when forming an assessment of what is going on with inflation.

The sectoral factor model of core inflation approaches the issue by separating components of the CPI into tradables (products that are imported, or that compete with imports) and non-tradables (products that are not exposed to international factors). By distinguishing between these two sectors, the prices of which are widely regarded as being influenced by different set of factors, the model allows an interpretation of what is driving core inflation.

Some improvements

RBNZ made some improvements recently to the sectoral factor model.

These are a part of the Bank’s on-going work to improve our suite of models.

The revised model gives an estimate of core inflation that is less volatile than before, and has slightly less marked cycles – lower peaks and higher troughs.

The broad cyclical behaviour of the new estimate is almost similar to the previously published estimate. However, there are some episodes in history where the qualitative picture of core inflation, on this measure changes after revision.

The revised data are now available in Table M1 (Prices) on the RBNZ.

The above is a non-technical summary to the analytical notes relating to the revisions made by Reserve Bank of New Zealand to its sectoral factor model of core inflation. For full version including the detailed analysis, please visit www.rbnz.govt.nz

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