Friday, August 7, 2015

Trimmed Mean PCE Inflation Rate Series Description

The Dallas Federal Reserve explains:

In spite of the arcane-sounding name, the concept of a trimmed mean is a simple one. In fact, trimmed means should be familiar to any follower of international figure skating. In the wake of the controversies surrounding the judging at the 2002 Winter Olympics, the International Skating Union adopted a scoring system in which a skater’s highest and lowest marks are discarded before the skater’s average score is calculated. Trimmed mean inflation rates are derived by a similar procedure.

In any given month, the rate of inflation in a price index like the Consumer Price Index or Personal Consumption Expenditures (PCE) can be thought of as a weighted average, or mean, of the rates of change in the prices of all the goods and services that make up the index. Calculating the trimmed mean PCE inflation rate for a given month involves looking at the price changes for each of the individual components of personal consumption expenditures. The individual price changes are sorted in ascending order from “fell the most” to “rose the most,” and a certain fraction of the most extreme observations at both ends of the spectrum are—like a skater’s best and worst marks—thrown out, or “trimmed.” The inflation rate is then calculated as a weighted average of the remaining components.

For the series presented here, 24 percent of the weight from the lower tail and 31 percent of the weight in the upper tail are trimmed. Those proportions have been chosen, based on historical data, to give the best fit between the trimmed mean inflation rate and proxies for the true core PCE inflation rate. The resulting inflation measure has been shown to outperform the more conventional “excluding food and energy” measure as a gauge of core inflation.