ECB paper presents new measure of underlying inflation

A working paper published by the European Central Bank presents a new measure for underlying inflation in the eurozone.

In PCCI – a data-rich measure of underlying inflation in the euro area, Marta Bańbura and Elena Bobeica explain the methodology of the persistent and common component of inflation (PCCI). Their new PCCI measure, they argue, is better in several ways than some existing measures of underlying inflation.  

The authors say the new index “reflects the view that underlying inflation captures widespread developments across the harmonised index of consumer prices (HICP) basket and that it is the persistent component of inflation”.

The new index relies on a generalised dynamic factor model, which is estimated on a large set of disaggregated HICP inflation rates for 12 eurozone countries. For each individual inflation rate, the authors estimate a low-frequency common component. They define this as “a component driven by shocks or factors that are relevant for all inflation series and capturing cycles longer than three years”.

The PCCI, the authors say, “is a weighted average of these common components”. This measure, they say, offers “an alternative to the typical exclusion-based measures used to gauge underlying inflation”, like HICP excluding food and energy. The PCCI does not a priori exclude any HICP items.

The new measure, the authors argue, “exhibits a set of desirable properties as a measure of underlying inflation. The PCCI acts as a good tracker of more lasting inflationary development, they say. “Furthermore, it is timely and signals turning points with some lead, while acting as an attractor for headline inflation.”