The Usefulness of the Median CPI in Bayesian VARs Used for Macroeconomic Forecasting and Policy

Brent Meyer and Saeed Zaman

Working Paper 2016-13
November 2016

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In this paper we investigate the forecasting performance of the median Consumer Price Index (CPI) in a variety of Bayesian vector autoregressions (BVARs) that are often used for monetary policy. Until now, the use of trimmed-mean price statistics in forecasting inflation has often been relegated to simple univariate or Phillips curve approaches, thus limiting their usefulness in applications that require consistent forecasts of multiple macro variables. We find that inclusion of an extreme trimmed-mean measure—the median CPI—improves the forecasts of both core and headline inflation (CPI and personal consumption expenditures) across our set of monthly and quarterly BVARs. Although the inflation forecasting improvements are perhaps not surprising given the current literature on core inflation statistics, we also find that inclusion of the median CPI improves the forecasting accuracy of the central bank's primary instrument for monetary policy: the federal funds rate. We conclude with a few illustrative exercises that highlight the usefulness of using the median CPI.

JEL classification: C11, E31, E37, E52

Key words: inflation forecasting, trimmed-mean estimators, Bayesian vector autoregression, conditional forecasting

First draft, February 2013, under the title, "It's Not Just for Inflation: The Usefulness of the Median CPI in BVAR Forecasting." Brent Meyer thankfully acknowledges that much of the research documented in this paper was performed while he was a member of the Research Department at the Cleveland Fed. The authors thank Todd Clark, Domenico Giannone, Edward Knotek II, Ellis Tallman, and Randy Verbrugge for their helpful criticisms and guidance. They also thank conference participants at the 35th International Symposium on Forecasting in Riverside, California. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta, the Federal Reserve Bank of Cleveland or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Brent Meyer, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, 404-498-8852,, or Saeed Zaman, Research Department, Federal Reserve Bank of Cleveland, P.O. Box 6387, Cleveland, OH, 44101-1387, 216-579-2991,
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