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Monetary policy and the measurement of inflation: prices, wages and expectations

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  • Bank for International Settlements
Abstract
Issues of inflation measurement are fundamental to the conduct of monetary policy. Price indices form the foundation of central bank policy frameworks around the world. They serve as guides to decision-making, as well as providing the primary mechanism for holding independent policymakers accountable. To shed some light on the role of inflation measurement, the annual meeting of Deputy Governors of emerging market economies (EMEs), held in Basel on 5-6 February 2009, explored three issues: price indices used by central banks; the role of wages and productivity in inflation policy; and the measurement and assessment of inflation expectations. This volume contains contributions by senior central bankers and BIS staff. The issues are summarised in an overview chapter by Stephen Cecchetti. Price indices used by central banks. The primary price indicator or target of EME central banks is headline CPI, supplemented by other indicators. At least two issues of measurement arise. The first is transitory phenomena, or noise, that should not affect policymakers' actions. Many central banks deal with noise by using measures of underlying or core inflation that exclude certain prices from computation in the index. The second issue is measurement biases, related to the way in which individual prices are weighted together to form an aggregate index (weighting bias; eg substitution bias); or due to actual errors in measuring the individual prices themselves (eg quality or new goods bias). Wages, productivity and structural inflation. Wages are a key element in the inflation process: wage growth equals productivity growth plus inflation and real wage growth that is in line with labour productivity growth is widely seen as a precondition for macroeconomic stability. In EMEs, a close relationship between real wage growth and labour productivity growth helps preserve external competitiveness while limiting inflationary pressures and the risk of a wage-price spiral developing. The adoption of inflation targeting frameworks by many emerging market central banks has provided an incentive to compile better labour market data and has enabled central banks to use productivity and unit labour costs more widely in their inflation forecasts. Other aspects of the role of wages in inflation are highlighted by two-sector models of differential productivity growth in tradable and non-tradable industries. One implication is that the rate of wage increase will depend on wage increase in the tradable sector. Another is that inflation sometimes reflect productivity growth in tradable industries, so not all inflation in rapidly-growing EMEs is necessarily undesirable or avoidable. Inflation expectations and monetary policy. Three issues may be highlighted that are discussed in this volume drawing on EME experience: (i) How central banks measure inflation expectations and use such measures; (ii) the relationship between inflation expectations and the costs of disinflation; and (iii) whether monetary policy frameworks are effective in anchoring inflation expectations. Measurements of expectations draw either on surveys (of households and businesses, professional forecasters and financial market participants) or financial markets (eg the difference in return between an inflation-linked bond and a nominal rate). As for the costs of disinflation, these are related to inflation persistence, which can in turn be related to expectations (eg backward-looking, or reflecting limited information about central bank objectives). Finally, the experience of central banks suggests that inflation expectations have been better anchored in this decade.

Suggested Citation

  • Bank for International Settlements, 2010. "Monetary policy and the measurement of inflation: prices, wages and expectations," BIS Papers, Bank for International Settlements, number 49.
    • Handle: RePEc:bis:bisbps:49
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    References listed on IDEAS

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    2. Jerry Hausman, 2002. "Sources of Bias and Solutions to Bias in the CPI," NBER Working Papers 9298, National Bureau of Economic Research, Inc.
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    8. Miguel Saldarriaga & Pablo del Aguila & Kevin Gershy-Damet, 2017. "Has inflation targeting anchored inflation expectations? Evidence from Peru," Working Papers 103, Peruvian Economic Association.
    9. Kiran Ijaz & Muhammad Zakaria & Bashir A. Fida, 2014. "Terms-of-Trade Volatility and Inflation in Pakistan," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 19(1), pages 111-132, Jan-June.
    10. Jorge Fornero & Markus Kirchner & Andrés Yany, 2015. "Terms of Trade Shocks and Investment in Commodity-Exporting Economies," Central Banking, Analysis, and Economic Policies Book Series, in: Rodrigo Caputo & Roberto Chang (ed.),Commodity Prices and Macroeconomic Policy, edition 1, volume 22, chapter 5, pages 135-193, Central Bank of Chile.
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    13. Winkelried, Diego & Gutierrez, José Enrique, 2012. "Regional inflation dynamics and inflation targeting in Peru," Working Papers 2012-018, Banco Central de Reserva del Perú.
    14. Diego Winkelried & José Enrique Gutierrez, 2015. "Regional Inflation Dynamics and Inflation Targeting. The Case of Peru," Journal of Applied Economics, Taylor & Francis Journals, vol. 18(2), pages 199-224, November.
    15. Ariel Weinberger, 2015. "Markups and misallocation with trade and heterogeneous firms," Globalization Institute Working Papers 251, Federal Reserve Bank of Dallas.
    16. Winkelried, Diego & Gutiérrez, José, 2012. "Dinámica inflacionaria regional y el esquema de metas de inflación en el Perú," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 24, pages 79-98.
    17. Carlos Huertas Campos & Eliana González Molano & Cristhian Ruiz Cardozo, 2015. "La formación de expectativas de inflación en Colombia," Borradores de Economia 12699, Banco de la Republica.
    18. Leilane de Freitas Rocha Cambara & Roberto Meurer, Gilberto Tadeu Lima, 2019. "Deviating from Perfect Foresight but not from Theoretical Consistency: The Behavior of Inflation Expectations in Brazil," Working Papers, Department of Economics 2019_36, University of São Paulo (FEA-USP).
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