Measures of “Trend” Inflation

Abstract

(FOMC) adopted a 2% inflation target. The inflation target they chose was based on the percentage change in the all-items (headline) personal consumption expenditures price index (PCEPI). The FOMC noted that deviations from the 2% target rate were likely in response to economic and financial developments, but that under appropriate monetary policy, inflation would average 2% over the longer run. In conventional models of inflation, the 2% inflation target rate—if credible—becomes a reasonable proxy for trend inflation and helps anchor long-run inflation expectations. Over time, then, under a credible monetary policy, headline inflation should converge to its long-run trend rate, which is primarily determined by the monetary authority. Thus, the FOMC attempts to measure trend inflation because it is a potentially useful guideline for predicting future inflation over the time horizon the FOMC cares about (typically 1 to 3 years). Many FOMC members view core PCEPI as an acceptable measure of trend inflation, as it excludes food and energy prices from the all-items PCEPI. Measures of “Trend” Inflation