While it has a short history, I put more weight on the New York Fed’s survey because its methodology should be more robust in accurately assessing consumer inflation expectations. Compared to the more widely followed University of Michigan survey, for example, the New York Fed survey has several advantages. The sample size is larger, most of the people that are interviewed are the same each month, and the inflation expectations question is posed differently to focus the respondent’s attention on inflation rather than on prices. We believe that all these factors lead to a more reliable estimate of inflation expectations.

Right now, we are trying to understand the dynamics of inflation The headline personal consumption expenditures (PCE) price index fell 0.2 percent in December. Its 12-month increase was 0.75 percent, down from 1.6 percent in June. Should this low, and still falling, rate of price inflation retard the date of the liftoff from the zero-interest-rate policy we have been operating for more than six years?

I think not. We all know that headline inflation is being held down by the big decline in energy prices that began in the second half of 2014. We know that once energy prices stabilize, headline inflation is likely to bounce right back up. Policy needs to take past inflation into account, but it needs to take future inflation into account, too. Thats just another way of saying that, for policy purposes, its inflations medium-term trend that matterswhich is why analysts and policymakers pay so much attention to core inflation measures. The widely heralded FRB/US model that has been used by the Board of Governors staff since 1996 is an example: It is built around PCE inflation excluding food and energywhich is the traditional measure of core inflation. Ex-food-and-energy PCE inflation was essentially zero in December, month over month, while the 12-month rate slipped to 1.3 percent from 1.5 percent in June.
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A good core inflation measure strips the noise out of headline inflation and leaves the signal. By that standard, recent analysis shows that the ex-food-and-energy PCE inflation rate that drives the FRB/US inflation forecast is a second-rate core inflation measure, at best. An alternative measure developed at the Dallas Fedthe Trimmed Mean PCEis superior in three respects.

First, trimmed mean inflation is better insulated from transitory energy-price swings. Since 1994 (the start of the current 2 percent-inflation era), conventional core inflations correlation with changes in the real price of oil is 0.26, while trimmed mean inflations correlation is just 0.05.

Second, as judged by root-mean-square error, it is more closely aligned with intuitive, direct measures of trend headline inflationlike the 36-month centered average, or headline inflations average over the coming 24-month periodthat we are only able to observe after the fact.

Third, trimmed mean inflation has shown substantially less systematic bias. Over the past 10 years, looking only at data that would have been available to policymakers in real time, conventional core PCE inflation has averaged 1.65 percentnearly 30 basis points below headline inflations 1.94 percent average. Meanwhile, trimmed mean inflation has come in at 1.83 percentjust 10 basis points below headline. Setting policy using conventional core as your guide is like navigating using a compass: It has a systematic bias and is influenced by local anomalies in the Earths magnetic field. Using the trimmed mean to set policy is more akin to navigating by GPS.

And while I think the Bureau of Labor Statistics and Bureau of Economic Analysis do fantastic jobs of collecting and distilling inflation data, I also look atand point critics tomore straightforward assessments like the Billion Prices Project from the Massachusetts Institute of Technology.8 This tool scrapes the Internet for prices, giving a daily reading of, well, billions of prices of myriad products. It lacks the complicated adjustments and methods that characterize the government agencies models. Nonetheless, it does track pretty closely with the official numbers. Whats more, it gives an independent assessment of consumer prices that is helpful for those who may distrust official federal data. While the BPPs numbers run a tad higher on average than the official indices, it shows that price inflation remains low and shows no sign of taking off.

The signal from all these indicators, both government and independent, point to the same conclusion: Inflation trends are quite modest. As I said, I expect that we will be moving back toward our 2 percent longer-run goal over the next few years.

An accurate measure of inflation is important for both the U.S. federal government and the Federal Reserve's Federal Open Market Committee (FOMC), but they focus on different measures. For example, the federal government uses the CPI to make inflation adjustments to certain kinds of benefits, such as Social Security.3 In contrast, the FOMC focuses on PCE inflation in its quarterly economic projections and also states its longer-run inflation goal in terms of headline PCE…

Given that the two indexes show different inflation trends in the longer run, having a single preferred measure that is used by both the federal government and the FOMC might be appropriate…

The FOMC carefully considered both indexes when evaluating which metric to target and concluded that PCE inflation is the better measure. In my view, headline PCE should become the standard and, therefore, should be consistently used to estimate and adjust for inflation. Although adopting a standard measure would likely not be a simple matter, it would provide clarity to the public about which one more accurately reflects consumer price inflation.

Well, we chose the PCE index for some, I think, very valid technical reasons. It better allows—better accounts for changes in people’s purchasing patterns; you know, when some things become more expensive, people will tend to move to other types of goods and services. That’s not accounted for by the CPI, which has fixed weights. 

It also—the PCE—I think more relevant to the average person, the PCE includes all health-care costs, not just out-of-pocket costs, and that has two benefits. One is, it reduces the share of the inflation index which is tied to housing. And the CPI has a very large share devoted to housing, and a large share of that part of the index is imputed—that is, essentially made-up numbers. So that’s one benefit, to keep the—you know, not to put too much weight on the imputed housing numbers, which is part of the CPI. The other is that, even if people are not paying for health care immediately out-of-pocket, they do pay for it, either through taxes or through reduced wages as, you know, increased health-care costs raise insurance premiums for employers. So I think this is probably a better measure of the inflation that’s faced by typical consumers than the CPI is. That being said, these various measures—the CPI and others, PCE index and others—move very closely together, and you’re not going to have a situation where the CPI is 10 percent and the PCE is 2 percent. There may be a few tenths difference, but, generally speaking, they move very closely together. So, in that respect, I think if people look at the CPI, they should feel pretty comfortable that, you know, that’s going to be very close to where the PCE inflation is.

I think if I now had to write down a number, I’d probably write 2%.

As reported by Wall Street Journal Real Time Economics Blog.

In my view, the compositional differences {between the CPI and PCE price index} don't clearly favor one index versus the other. While the level of the inflation rate measured by the two indices differs at any point in time, over the short term both generally give the same signal about the pattern of inflation.

Taken together, measures of both CPI and PCE inflation are important tools to help get a fix on the overall inflation picture, giving us a sense of whether the inflation is persistent or transitory along with other information needed to make informed policy decisions.
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I agree with those who say core inflation measures in isolation are an inadequate approach to determining the direction of overall price changes. Like you, I ultimately care about the trend rate of overall inflation, which I believe is ultimately the appropriate object of monetary policy.

[R]ecent research done at the Federal Reserve Bank of New York on U.S. data finds that no one particular core measure, including the standard one, dominates the others:  The relative performance of different core measures varies depending on the choice of the price index, the sample period, and the criteria for evaluating their performance (Rich and Steindel, 2007).  Research on Canadian and U.K. data comes to similar conclusions (Hogan, Johnson, and Laflèche, 2001; Mankikar and Paisley, 2002).

Does the lack of empirical support for any one particular type of core measure suggest that our focus on the standard core measure should be abandoned?   I think not.  The simplicity and long history of the standard core measure that excludes food and energy gives it several major advantages.  Its simplicity makes it straightforward to explain and thus more understandable to the public--assuming, of course, that we successfully communicate that we recognize the importance of food and energy items in people's consumption. 

Right now our policy rate ... is moderately restrictive. Not severely, but modestly so. And that allows for the economy to continue to grow ... and slowly, hopefully, bring down the inflation rates for CPI, the core CPI, to levels even closer to 2 percent as we move forward.

As reported by Reuters

Some of my earlier concerns about the core CPI have diminished, in part because my concerns about the core PCE have increased.

As reported by the Wall Street Journal

So we have to be careful not to focus too narrowly on one particular measure. Instead we need to look at many. And indeed here in the United States we look at a range of different measures of core inflation, for example, that take energy and food prices out of the overall index. We look at these over different time horizons. We look at a variety of other measures that use different statistical techniques to strip out the more volatile parts of the index. These all have limitations, and their relative merits may change over time. Central banks approach this challenge of capturing underlying inflation differently, but ultimately we are all judged by what happens to overall inflation over time.

I believe it is improtant to monitor a range of inflation measures in conducting monetary policy.  No single measure can, by itself, provide enough information with which to form a well-founded judgment about the prospects for inflation and economic growth.  Among the many inflation measures I consider are indexes of consumer prices (including the Personal Consumption Expenditure price index and the Consumer Price Index)--both the headline indexes and the indexes that exclude the eratic prices of food and energy; the price indez for gross domestic purchases (the broadest price measure of domestically purchased goods and services); and the price index for Gross Domestic Product (the broadest price measure of domestically produced goods and services)...Similarly, I find it useful to look at a variety of forward-looking measures of inflation when considering the economic outlook.

Although the C-CPI-U [Chained CPI-U] is still subject to other sources of bias--especially those related to changes in the quality of existing products and the introduction of new goods and serives--basing inflation indexation of federal programs on the C-CPI-U would, in my view, give us a less biased measure of changes in the cost of living.

For those of you who did not have an opportunity to hear my earlier remarks, you might ask why the U.S. should move forward on inflation targeting now. For 25 years, the Fed has steadily reduced inflation and inflation expectations, without resorting to an explicit inflation target...

However, having achieved price stability, there is still the matter of maintaining it. I believe an explicit inflation target can help us do that.

...My inflation targeting proposal is this:

The Fed should establish a target band of 1 to 3 percent for annual inflation, as measured by the 12-month moving average rate of change in the core PCE deflator.