TheUnreliabilityofInflationIndicators.pdfVIP

FEDERAL RESERVE BANK OF NEW YORK IN ECONOMICS AND FINANCE April 2000 Volume 6 Number 4 The Unreliability of Inflation Indicators Stephen G. Cecchetti, Rita S. Chu, and Charles Steindel Analysts seeking evidence of rising inflation often focus on the movements of a single indicator—an increase in the price of gold, for example, or a decline in the unemployment rate. But simple statistical tests reveal that such indicators, used in isolation, have very limited predictive power. Controlling inflation—perhaps the most vital responsi- Inflation Indicators bility of the Federal Reserve—requires a high degree Movements in certain economic and financial market of foresight. Because policy actions to curb inflation variables are thought to presage changes in the CPI and typically take effect only after a long lag, the Federal other broad inflation measures. Nineteen variables often Reserve needs to know in advance when inflation is proposed as inflation indicators are listed in Table 1. For likely to rise. Consequently, to understand where prices ease of understanding, we can group all but one of these are headed and what policy steps are appropriate, policy- variables into three broad classes: makers turn to forecasts of inflation. XCommodity prices, such as specific prices for In this edition of Current Issues, we consider the oil and precious metals, or indexes of a group usefulness of certain “indicator variables” in forecast- of such goods. Increases in these measures— ing inflation. These variables—which include commod- either in their level or in their rate of growth— ity prices, financial market measures, and measures of are frequently linked to higher inflation. real economic activity—are widely thought to be linked