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Bryan, Michael F.; Brent Meyer,. "Are some prices in the CPI more forward looking than others? We think so." Economic Commentary (Cleveland). Federal Reserve Bank of Cleveland. 2010. HighBeam Research. 25 Apr. 2018 <https://www.highbeam.com>.
Bryan, Michael F.; Brent Meyer,. "Are some prices in the CPI more forward looking than others? We think so." Economic Commentary (Cleveland). 2010. HighBeam Research. (April 25, 2018). https://www.highbeam.com/doc/1G1-229721332.html
Bryan, Michael F.; Brent Meyer,. "Are some prices in the CPI more forward looking than others? We think so." Economic Commentary (Cleveland). Federal Reserve Bank of Cleveland. 2010. Retrieved April 25, 2018 from HighBeam Research: https://www.highbeam.com/doc/1G1-229721332.html
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Like it or not--and there are many in the "not" camp--the workhorse for forecasting medium-term inflation is the expectations-augmented Phillips curve, variations of which are sometimes called New Keynesian Phillips curves. In this forecast, often produced from a single price aggregate like the Consumer Price Index (CPI) or the price deflator for personal consumption expenditures, inflation is a function of two forces: the inflation expectations of the public and the amount of slack in the economy. Inflation expectations are an important consideration in wage and price decisions, and slack influences the pricing power of firms and workers.
Of course, the basic forces that shape the conventional inflation forecast do not do so in the same way for all prices. For example, some prices are "sticky," which means that they may not respond to changing market conditions as quickly as other, more "flexible-price" goods. And because sticky prices are slow to change, it seems reasonable to assume that when these prices are set, they incorporate expectations about future inflation to a greater degree than prices that change on a frequent basis.
In this Commentary, we use the published components of the CPI to compute two subindexes, a sticky-price composite of the CPI and a flexible-price CPI. We believe the evidence indicates that the flexible-price measure is, in fact, much more responsive to changes in the economic environment-slack--while the sticky-price variant appears to be more forward looking.
Price Stickiness in the Consumer Price Index
What makes a price sticky? The answer to this question has puzzled economists since John Maynard Keynes built his General Theory around sticky prices more than 70 years ago. The prevailing belief is that, in some markets, changing prices can involve significant costs. These costs can greatly reduce the incentive of firms to change prices.
While a sticky price may not be as responsive to economic conditions as a flexible price, it may do a better job of incorporating inflation expectations. Since price setters understand that it will be costly to change prices, they will want their price decisions to account for inflation over the periods between their infrequent price changes.
While some economists wrestle with the question of what, exactly, causes prices to be sticky, others have taken on the tedious task of documenting the speed at which prices adjust. The most comprehensive investigation into how quickly prices adjust that we know of was published a few years ago by economists Mark Bils and Peter Klenow. Bils and Klenow dug through the raw data for the 350 detailed spending categories that are used to construct the CPI. They found that half of these categories changed their prices at least every 4.3 months. Some categories changed their prices much more frequently; price changes for tomatoes, for example, occurred every three weeks. And some goods, like coin-operated laundries, changed prices on average only every 6 1/2 years or so. …
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