Staff working paper No. 31
By Danny T Quah and Shaun P Vahey
In this paper, we argue that measured (RPI) inflation is conceptually mismatched with core inflation: the difference is more than just "measurement error". We propose a technique for measuring core inflation, based on an explicit long-run economic hypothesis. Core inflation is defined as that component of measured inflation that has no (medium to) long-run impact on real output-a notion that is consistent with the vertical long-run Phillips curve interpretation of the comovements in inflation and output. We construct a measure of core inflation by placing dynamic restrictions on a vector autoregression (VAR) system.
Measuring Core Inflation