Sunday, February 13, 2011

How the Fed thinks about Inflation

I was reading a posting by one of the analysts for the Atlanta Fed
talking about how people say there's a disconnect between what Bernanke says about inflation and what businessmen and consumers think is happening with inflation. His main point was that they don't just plug into a formula. They have a pretty elaborate system of interviewing a lot of people (businessmen and consumers) about the data and their impressions too.

But mostly I thought it was interesting that he says the Fed doesn't favor CPI (core or otherwise) as their favorite inflation index. They like something called the "personal consumption expenditures price index" PCEPI.
So far as I can figure from Wikipedia, the biggest difference vs. CPI is that it attempts to adjust for substitutions people might make if one item gets particularly expensive. It tends to make PCEPI a bit lower.

Another interesting thing: Wikipedia linked from PCEPI to a page on price indices in general. Complicated!
I had read some things about how the Case-Shiller housing price index is calculated and it's pretty intricate.
They try to make the index take into account the variation in which particular houses are sold in an area. So based on previous sales of the same house, they try to create an adjusting factor for the houses sold in a particular year.

But there are lots of choices to make. The Case-Shiller index is supposed to show a percent change in housing prices in a given area. Do you weight by the prices of houses so big houses count more than small houses? They do.
(A simple average would effectively do the same thing). But I can see why you wouldn't.


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