Median Inflation Gauge Offers Better Read on Price Trends

IMF Blog, February 14, 2022

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Publication date: February 14, 2022
Authors: Laurence Ball, Daniel Leigh, Prachi Mishra, Antonio Spilimbergo
Problem: Stripping out volatile price changes to gauge underlying inflation pressures in the United States during and after the pandemic.
Context: The traditional "core" inflation measure excludes food and energy and came into wider use in the 1970s when volatile energy prices caused inflation spikes.

The traditional core measure was almost as volatile as headline inflation for most of the past two years because many large price changes occurred outside of food and energy (examples: airlines, hotels, sporting events, and financial services).
Outlier-exclusion measures perform best at filtering transitory movements:
- Cleveland Fed median: shows the item in the middle of the range of all price changes every month.
- Dallas Fed trimmed-mean: omits items in the bottom 24 percent and top 31 percent of the distribution each month.
Both the Cleveland median and Dallas trimmed-mean:
- Filter out most monthly fluctuations in headline inflation and have been relatively stable.
- Are more closely related to unemployment and other indicators of economic slack than either headline inflation or the traditional core measure.
- Drifted down when the economy contracted in 2020 and then rose as the economy rebounded.
These alternative core inflation gauges steadily increased during 2021, confirming that underlying inflation trends in the US have risen.

Over the three decades preceding the pandemic, measures that strip out a greater share of outlier price movements were:
- Less volatile than the traditional core inflation (excluding food and energy).
- More reliably related to unemployment and macroeconomic conditions.
Inflation excluding food and energy was more volatile than median and trimmed mean inflation and had a much weaker relationship with macroeconomic conditions.
The Bank of Canada adopted a weighted median and a trimmed mean as primary measures of core inflation in 2016, replacing their traditional core measure.

The case for the Federal Reserve to move away from the traditional measure of core inflation has strengthened during 2020-21.
Using outlier-exclusion gauges can improve assessment of underlying inflation pressures and their relation to economic slack, informing monetary policy decisions.

Source: IMF Blog — "Median Inflation Gauge Offers Better Read on Price Trends" (February 14, 2022).