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Asset Prices in the Measurement of Inflation

Author

Listed:
  • Michael F. Bryan
  • Stephen G. Cecchetti
  • Roisin O'Sullivan
Abstract
The debate over including asset prices in the construction of an inflation statistic has attracted renewed attention in recent years. Virtually all of this (and earlier) work on incorporating asset prices into an aggregate price statistic has been motivated by a presumed, but unidentified transmission mechanism through which asset prices are leading indicators of inflation at the retail level. In this paper, we take an alternative, longer-term perspective on the issue and argue that the exclusion of asset prices introduces an 'excluded goods bias' in the computation of the inflation statistic that is of interest to the monetary authority. We implement this idea using a relatively modern statistical technique, a dynamic factor index. This statistical algorithm allows us to see through the excessively 'noisy' asset price data that have frustrated earlier researchers who have attempted to integrate these prices into an aggregate measure. We find that the failure to include asset prices in the aggregate price statistic has introduced a downward bias in the U.S. Consumer Price Index on the order of magnitude of roughly 1/4 percentage point annually. Of the three broad assets categories considered here -- equities, bonds, and houses -- we find that the failure to include housing prices resulted in the largest potential measurement error. This conclusion is also supported by a cursory look at some cross-country evidence.

Suggested Citation

  • Michael F. Bryan & Stephen G. Cecchetti & Roisin O'Sullivan, 2002. "Asset Prices in the Measurement of Inflation," NBER Working Papers 8700, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:8700
    Note: AP ME
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    References listed on IDEAS

    as
    1. Alchian, Armen A & Klein, Benjamin, 1973. "On a Correct Measure of Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 5(1), pages 173-191, Part I Fe.
    2. Michael F. Bryan & Stephen G. Cecchetti, 1993. "The consumer price index as a measure of inflation," Economic Review, Federal Reserve Bank of Cleveland, vol. 29(Q IV), pages 15-24.
    3. repec:bla:manchs:v:68:y:2000:i:0:p:122-40 is not listed on IDEAS
    4. Hiroshi Shibuya, 1992. "Dynamic Equilibrium Price Index: Asset Price and Inflation," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 10(1), pages 95-109, February.
    5. Mark A. Wynne, 2008. "Core inflation: a review of some conceptual issues," Review, Federal Reserve Bank of St. Louis, vol. 90(May), pages 205-228.
    6. James H. Stock & Mark W. Watson, 1988. "A Probability Model of The Coincident Economic Indicators," NBER Working Papers 2772, National Bureau of Economic Research, Inc.
    7. Shiratsuka, Shigenori, 1999. "Asset Price Fluctuation and Price Indices," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 17(3), pages 103-128, December.
    8. Robert A. Pollak, 1975. "The Intertemporal Cost of Living Index," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 4, number 1, pages 179-198, National Bureau of Economic Research, Inc.
    9. Stephen G. Cecchetti, 1997. "Measuring short-run inflation for central bankers," Review, Federal Reserve Bank of St. Louis, issue May, pages 143-155.
    10. Tullock, Gordon, 1979. "When Is Inflation Not Inflation: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(2), pages 219-221, May.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation

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