It's Not Just for Inflation: The Usefulness of the Median CPI in BVAR Forecasting

Abstract

In this paper we investigate the forecasting performance of the median CPI in a variety of Bayesian VARs (BVARs) that are often used for monetary policy. Until now, the use of trimmed-mean price statistics in forecasting infl ation has often been relegated to simple univariate or "Philips-Curve" approaches, thus limiting their usefulness in applications that require consistent forecasts of multiple macro variables. We fi nd that inclusion of an extreme trimmed-mean measure-the median CPI-signifi cantly improves the forecasts of both headline and core CPI across our wide-ranging set of BVARs. While the infl ation forecasting improvements are perhaps not surprising given the current literature on core infl ation statistics, we also fi nd 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.

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