Stability price index, core inflation and output volatility

Abstract

This article examines the relationship between the ‘exclusion’ type Core Inflation (CI) measures and the stability price index. Empirical results for Malaysia and Pakistan suggest that if targeting CI index is to stabilize output, weights of the export-oriented sectors (energy for Malaysia and foodstuffs for Pakistan) should be reduced, in relation to the CPI weights, and weights of the import-oriented sectors should be increased. It also indicates that, in order to maintain real sector stability, central bankers should include the fundamental component of the stock market prices in the price index they target.

Keywords:

• price index
• monetary policy
• output stability
• financial markets

JEL Classification:

• E52
• E58
• G12

Acknowledgements

We acknowledge support of the ESRC/ORA Project 10-003 Probabilistic Approach to Assessing Macroeconomic Uncertainties. We are also grateful to Victoria Majewska for help with programming and Ricardo Reis for his helpful suggestions. This research used the ALICE High Performance Computing Facility at the University of Leicester.

We are solely responsible for the remaining deficiencies.

Notes

¹ Main sources: http://www.statistics.gov.my for Malaysia and http://www.sbp.org.pk/publications/index2.asp for Pakistan. For Malaysia, the data on energy prices are combined with that on housing prices and given identical weights in the CPI.

² The optimization algorithm applied here is Newton–Raphson method with step-halving. Computations have been performed using optimization module OPTMUM of GAUSS, version 12, produced by Aptech Systems Inc. (www.aptech.com).