It is generally accepted in the economics literature that there is an underlying inflation rate that raises the general price level and simultaneously degrades the value of money. This common force purportedly influences prices of all goods and services in the economy. Price changes of individual items can vary based on short-term, idiosyncratic fluctuations, but they are assumed to gravitate to the dominant underlying inflation rate over time. All government and private inflation measurements are based on this concept of inflation. This paper takes a sectoral approach to assess this basic assumption of a common force pulling all individual prices. How strong is this underlying force relative to short-term volatility? What proportion of prices are represented by measures of inflation? This paper finds that price changes are widely diffused across sectors, and that only a small portion of price changes are approximated by standard inflation measures. This suggests that the gravitational pull from underlying inflation is weak in the short term, calling into question the accuracy of standard inflation measures. One important implication of this analysis is that monetary policymakers should aim for measured inflation to be in a target band, rather than an explicit value of 2 percent.
Available at: http://works.bepress.com/peter-dantonio/1/