Core Inflation

A latent dynamic factor model that extracts the core inflation trend using a combination of various economy wide indicators of prices. The model is a state space model with a time varying parameter that describes the core inflation rate. The model is estimated using a Kalman Filter.

Factor loadings

The matrix Z in the observation equation is the factor loadings matrix that describes the relationship between the observed data and the latent core inflation rate, where the more stable and common underlying sectors (food, housing, transport) have greater weight than volatile idyiosyncratic sectors (communication, clothing & footwear).

Comparing the factor loadings to the ABS expenditure weights used for all groups CPI, shows that the volatility adjusted dynamic factor model has a significantly lower weight on housing and generally higher weights on education, insurance, alcohol and tobacco and health.