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“But in times like these, it's not clear why the reference point should be a period when gasoline prices were at $1.30/l. Indeed, as the reference point moves to where gasoline prices hit their peak, we should expect the y/y number to drift even lower. But that's simply an artifact of the convention of reporting only the average rate of inflation over the past 12 months: why not the past 3 years, or the past 3 months?”

Thanks for saying this. The focus on the year over year numbers in both Canada and the US struck me as odd given that the degree of monetary accommodation changed substantially in the fall and then again this spring (with QE in the US).

I also have a question (with a longish intro).

My assumption has been that one of the dangers of using various inflation measures as a guide to monetary policy is the possibility that the figure could be distorted or biased by relative price changes and therefore be a poor indicator of changes in the overall price level. Presumably, this could arise if the index included price changes for certain goods(which might reflect relative price increases, for example) but excluded those for others (which might reflect compensating relative price decreases). Setting aside the issue of existing asset prices, the equation of exchange implies that the ideal index would reflect all GNP-component transactions (doesn’t it?). Given that, I don’t understand why such emphasis is placed on the prices of certain baskets of consumer goods. The use of a less than completely broad-based index then necessitates the exclusion of the relatively more volatile prices (i.e., gasoline and food) which presumably are more likely to represent relative price changes.

Why isn’t a more broadly-based inflation measure/target used?


"Setting aside the issue of existing asset prices, the equation of exchange implies that the ideal index would reflect all GNP-component transactions (doesn’t it?)."

I don't see why that follows. If the definition of Pb that the Bank of Canada targets is different from the Pa in MV=PY, then the Bank will need to allow M to vary to offset changes in Pb/Pa. But the Bank would not necessarily see that as a problem, since it is letting M vary anyway.

The main argument for targeting CPI is that it is a definition of the price index that the public is familiar with. It also roughly represents the price index needed to deflate nominal income to get real purchasing power.

But the argument against targeting CPI is this: some prices are sticky, and some are flexible. The sticky prices don't want to change, and if we try to make them change, we get problems, like excess demand or supply. So the point of monetary policy is to try to make sure that the prices that don't want to change don't need to change.

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