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Is price deflation being overstated?

Professor Greg Mankiw of Harvard University has just pointed out that the CPI figure in the US which has moved into negative territory, may be exaggerated because it is based on a “trimmed mean estimate”, which removes the large relative price changes in each month.


He says: “As every grade school student learns when the teacher reports results of the latest test, the average of any data set can be thrown off by a few extreme outliers; the median is a more robust statistic to estimate the central tendency in the data.


“Right now, the two measures of inflation are diverging substantially. The standard CPI shows deflation over the past year, but that average is due to a few anomalous sectors, such as energy. If you look at the median CPI, which shows what a more typical price is doing, the inflation rate does not look very unusual.”

In fact the Federal Reserve Bank of Cleveland maintains such a “median” measure which can be seen in the graphic below. To view a larger image of the graph click here.


Source: Federal Reserve Bank of Cleveland

Source: Federal Reserve Bank of Cleveland


Whether this shows that deflation is not currently a threat in the US is open to further interpretation. I have unearthed an article by Bryan and Pike (1991) and published by the Cleveland Fed which concludes:


“Differences between changes in the CPI and the median consumer price change underscore the impact of the distribution of price movements on our monthly interpretation of inflation. The median price change is a potentially useful indicator of current monetary inflation because it minimises, in a non-subjective way, the influence of these transitory relative price movements.”


However, the authors go on to say that: “Whether the median change is an accurate long-run inflation measure is an entirely different matter – one that depends in part on whether monetary inflation causes, or otherwise perpetuates, relative price fluctuations …. It may be that monetary inflation and relative price changes are related. One possible linkage may be through a monetary transmission mechanism, whereby changes in the quantity of money influences all prices, but at different times. If fluctuations in the distribution of price changes are predominantly monetary in origin, then what economists commonly disregard as relative price noise may actually be leading (or lagging) indicators of a more broadly transmitted monetary inflation.”


So, perhaps the evidence is not quite as transparent as Mankiw suggests.

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Posted in Consumer Price Index, Deflation, Interest rates, US economy

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