Think tank questions value of core CPI

The Bank of Canada should reconsider its use of core CPI as an “operational guide,” according to a report released today by the C.D. Howe Institute.

The report, penned by Philippe Bergevin and Colin Busby, suggests “items excluded from core inflation may possess valuable information about future headline inflation, and cautions against emphasizing a single price measure to represent complex underlying inflationary trends.”

The authors’ empirical analysis suggests “different measures for underlying inflation work better in alternative time periods. For instance, from 1995–2001 WMedian and CPIW were better predictors of headline inflation than the Bank’s official measure of core, whereas from 2002–2011 the Bank’s measure of core and CPI8 each proved a superior predictor. The lesson is that no single measure for underlying inflation always works best.”

The report also notes the disjuncture that often arises between the Bank’s public communications based on core CPI and the day-to-day lives of their main audience—ordinary Canadians.

“The exclusion of items that are purchased often by customers—such as fruits, vegetables and gasoline—makes core CPI appear out of touch with their daily experiences.”

The authors warn that continued reliance on core CPI can “distract” the Bank from emerging inflationary pressures and seriously damage its credibility.

“If the Bank’s operational guide were to determine policy and happened to exclude items that were subject to a nontransient upward price shock, headline CPI would rise and remain above target for an extended period, undermining the Bank’s credibility and sowing the seeds of rising inflation expectations on the part of the public.”

Bergevin and Busby worry there are “strong reasons” to think this type of scenario could unfold in the years ahead.

“A number of long-term economic trends suggest that some of the components excluded from core—notably, those related to food and energy—could be more subject to continuing positive price shocks. Strong population growth, coupled with the continued industrialization of countries such as China and India, will ensure that scarce goods such as gasoline, fruits and vegetables are vulnerable to future price increases.”

Staff

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