Estimating Core Inflation - The Role of Oil Price Shocks and Imported Inflation

Abstract

This paper calculates core inflation, by imposing long run restrictions on a structural vector\nautoregression (VAR) model containing the growth rate of output, inflation and oil prices. Core\ninflation is identified as that component in inflation that has no long run effect on output. No\nrestrictions are placed on the response of output and inflation to the oil price shocks. The analysis is\napplied to Norway and the United Kingdom, both oil producing OECD countries. A model that\ndistinguishes between domestic and imported inflation, is also specified for Norway. In both\ncountries, core inflation is a prime mover of CPI (RPI) inflation. However, CPI (RPI) inflation\novervalues or undervalues core inflation in many periods, of which oil price shocks are important\nsources behind this deviation for prolonged periods\nKeywords: Core inflation, inflation target, long-run neutrality, oil price shocks, imported inflation,\nstructural VAR.

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