Alternative Measures of Underlying Inflation in the Euro Area

This paper proposes two measures of underlying inflation for euro area as an alternative to the Harmonized Index of Consumer Prices excluding Food and Energy. The first measure, called the Core cycle measure, is constructed by using a Phillips curve model to distinguish disaggregated prices that respond to the economic cycle (procyclical), from those which do not (acyclical). The second measure, called the Common core measure, is constructed using a factor model to remove components that are subject to large or unusual price changes, which are unlikely to be related to the underlying trend of inflation because of their idiosyncratic nature. Each measure has merits and shortcomings, suggesting that they should be taken together to assess inflation developments.