MBA 609 Money, Financial Markets, & Forecasting Homework #6

1. Use the cost of living calculator at bankrate.com to complete the following:

a. Compare the cost of living in two different locations in which you would consider living.

As an example, a salary of $100,000 in Salt Lake City would require $235,900 in Manhattan New York. The conversion ratio is $1 Salt Lake City to $2.36 Manhattan.

b. Discuss the accuracy and applicability relative to your situation of the basket of goods and services chosen by Bankrate.

The main problem is to get the basket of goods to match our personal situations. This probably isn’t a very relevant comparison since most people could never afford to buy or even rent in Manhattan. Also, the basket of good listed might not be the same that a BYU MBA, single or married, would purchase. Nonetheless, the salary comparisons do give a very rough comparison for the cost of living between two geographical locations.

c. Explain problems caused in price indexes as technological progress creates smartphones, tablets, and other new products.

The challenge that technological progress creates is that of simultaneously keeping the market basket of goods relevant and constant. Relevance requires evolution over time which violates the need for constancy. By chaining or buy multiple baskets of good over time, consistence prices indices can be created.

2. Calculate and graph the annualized monthly core inflation rate from the Personal Consumption Expenditure Price Index which excludes food and energy (PCEPILFE).

a. Use exponential smoothing to forecast the inflation rate for the next year.

Tableau produces the following graph for the annualized percentage change in the core PCE price index. We choose the annualized percentage change in this case because it is the traditional way that we have for calculating and report inflation rates. The Tableau model is simple exponential smoothing with alpha = 0.1 with the other smoothing constants equal to zero. This model forecasts core inflation of 1.4% for near future b. Explain why we exclude food and energy when calculating the core inflation rate.

Food and energy prices are very volatile so short-term changes in their prices are excluded. In the long run, if good and energy permanently cause an increase in the aggregate price level, then these changes will be reflected in the core PCE. c. The Federal Reserve has a goal of an inflation rate of 2% per year. If your forecast is correct, what should the Federal Reserve do?

The Fed hasn’t been able to hit its 2% inflation target for over a decade now. No matter how low the Fed has forced interest rates with Quantitative Ease, inflation refuses to grow to the desired level.