Because inflation is a rather long-term process, present and historical data should be useful in anticipating future inflation. We build two basic models that utilize information buried in past CPI inflation readings using that intuition. Each employs a different method for forecasting CPI inflation for the coming year: One is based on regression analysis, while the other is based on Atkeson and Ohanian’s nave specification (2001). We then add and remove different factors, as well as alternative techniques of measuring these variables, to arrive at different specifications.
The first specification is a regression that uses CPI lags to anticipate one-year-ahead CPI inflation (specifically, past values of the quarterly annualized percent change in the CPI).
1 This regression is estimated in a recursive fashion, starting with a sample of 40 quarters of data and adding an additional data point to the sample in each subsequent quarter.
2 This method equates to claiming that the next year’s inflation is a function of all previous inflation levels up to four quarters prior. The parameters of that function are determined through regression analysis.
The second specification uses a naive specification to estimate one-year-ahead CPI inflation, in which the projection for the year ahead is simply the CPI’s past four-quarter growth rate. For example, through the third quarter of 2010, the CPI’s four-quarter increase rate was 1.2 percent. Using the naive method, we anticipate 1.2 percent inflation for the next four quarters (through the third quarter of 2011). This method translates to suggesting that inflation in the following year will most likely be the same as it was the previous year.
We examine the predicting effectiveness of these models over a number of time periods because the underlying inflation process may have altered over time. Beginning in 1960, we look at forecast accuracy by decade. We next divide the data series into two time periods, one pre-1983 and one post-1983, because monetary policy altered in the 1980s. After a period of disinflation in the early to mid-1980s, known as the “Volcker-era” disinflation, both inflation and inflation expectations became less volatile, the inflation process may have been altered. We also look at forecast accuracy from 1984 to 2006 (excluding the last four years) to examine what has changed in the most recent era, which includes the 20072009 recession. The most recent time period we look at is 19952010, which allows us to look at inflation expectations as predictors for time periods where we have minimal data.
We compute the root mean squared error (RMSE) statistic, a measure of forecast error, for each specification to compare its accuracy. Positive numbers reflect differences between expected and realized values, whereas an RMSE of 0 denotes perfect forecasting performance. The greater the RMSE, the greater the average variation between projected and realized values. The forecast accuracy for our backward-looking regression and naive specification is shown in Table 1.
Table 1 shows a couple of patterns worth noting. To begin with, neither model consistently outperforms the other over time, while the naive strategy clearly has the advantage. Second, the predicting performance of these specifications, which are only based on previous inflation, fluctuates significantly over time and has decreased in recent years.
As a result of this recent loss in forecasting skill, inflation appears to be explained by past inflation to a lower amount than it used to be. The underlying inflation process may have changed, which could explain the decline. According to Carlstrom, Fuerst, and Paustian (2007), inflation has grown less persistent. Lagged inflation’s loss of explanatory power could be linked in part to the mid-2008 energy price shock. The CPI’s four-quarter growth rate had soared to 5.3 percent (a 17-year high) by the third quarter of 2008, only to plummet to 0.0 percent two quarters later. A big swing like that had not been seen in recent memory, and it is likely to have contributed to a larger forecast inaccuracy because backward-looking methods could not account for such severe fluctuation.
Is it possible to forecast inflation rates?
Various forecasting organizations place US CPI inflation in the range of 1.69 percent to 4.30 percent in 2022, and about 2.5 percent in 2023. CPI inflation is expected to fall in 2022 compared to 2021, according to almost all forecasting groups. The most current forecasts, on the other hand, show the opposite scenario. CPI inflation in the United States is predicted to be about 2.3 percent in the long run, up to 2024.
Is inflation predicted by economists?
Economics in Real Time According to the Labor Department’s consumer-price index, respondents predict annual inflation to be 5% in June, up from 3.4 percent in October. They anticipate a 3.1 percent inflation rate at the end of the year, up from a forecast of 2.6 percent in December 2022 previous quarter.
What is the expected rate of inflation in 2021?
According to Labor Department data released Wednesday, the consumer price index increased by 7% in 2021, the highest 12-month gain since June 1982. The closely watched inflation indicator increased by 0.5 percent in November, beating expectations.
What is the most accurate inflation predictor?
- Household inflation expectations, as measured by the University of Michigan Consumer Surveys one-year inflation expectations.
- Professional experts’ inflation expectations, as indicated by the Blue Chip Economic Indicators one-year inflation expectations for the consumer price index (CPI).
- Firms’ inflation expectations, as evaluated by the business inflation expectations survey conducted by the Federal Reserve Bank of Atlanta. Although we use it to estimate consumer price inflation, this measure measures expected rise in the firm’s production expenses over the following year. 1
- Financial market inflation expectations, as captured by the model behind the Federal Reserve Bank of Cleveland’s one-year-ahead inflation expectations data. The Cleveland model (Haubrich, Pennacchi, and Ritchken (2012) uses nominal yields from US Treasury securities, survey forecasts, and inflation swap rate data to assess inflation expectations. 2
All of these metrics of inflation expectations are accessible in a monthly series. Each of these indicators is compared to a variety of inflation indices, including CPI inflation, core CPI inflation, median CPI inflation, and trimmed-mean CPI inflation. The median CPI, which has been found to be beneficial in predicting future CPI inflation (Meyer, Venkatu, and Zaman, 2013) and other variables, is probably a stronger signal of the trend in CPI inflation than overall CPI inflation (Meyer and Zaman, 2019). We use nonseasonally adjusted, unrevised data to calculate year-over-year inflation rates for the CPI and core CPI. To compute year-over-year inflation rates for those variables, we use the most recent vintage of year-over-year median CPI and trimmed-mean CPI inflation data.
Since the mid-1980s, a considerable body of scholarship has demonstrated shifts in inflation dynamics (Aastveit et al, 2017). As a result, we concentrate on data from 1986 onwards, which corresponds to the beginning of the Blue Chip expectations measure. The Atlanta Fed’s business survey data is only accessible since October 2011.
What will be the rate of inflation in 2022?
According to a Bloomberg survey of experts, the average annual CPI is expected to grow 5.1 percent in 2022, up from 4.7 percent last year.
Is America simply printing cash?
The Federal Reserve of the United States oversees the country’s money supply, and while it does not produce currency bills, it does select how many are printed by the Treasury Department each year.
Will prices ever fall as a result of inflation?
The consumer price index for January will be released on Thursday, and it is expected to be another red-flag rating.
As you and your wallet may recall, December witnessed the greatest year-over-year increase since 1982, at 7%. As we’ve heard, supply chain or transportation concerns, as well as pandemic-related issues, are some of the factors pushing increasing prices. Which raises the question of whether prices will fall after those issues are overcome.
The answer is a resounding nay. Prices are unlikely to fall for most items, such as restaurant meals, clothing, or a new washer and dryer.
“When someone realizes that their business’s costs are too high and it’s become unprofitable, they’re quick to identify that and raise prices,” said Laura Veldkamp, a finance professor at Columbia Business School. “However, it’s rare to hear someone complain, ‘Gosh, I’m making too much money.'” To fix that situation, I’d best lower those prices.'”
When firms’ own costs rise, they may be forced to raise prices. That has undoubtedly occurred.
“Most small-business owners are having to absorb those additional prices in compensation costs for their supplies and inventory products,” Holly Wade, the National Federation of Independent Business’s research director, said.
But there’s also inflation caused by supply shortages and demand floods, which we’re experiencing right now. Because of a chip scarcity, for example, only a limited number of cars may be produced. We’ve seen spikes in demand for products like toilet paper and houses. And, in general, people are spending their money on things other than trips.
What can we anticipate in terms of inflation?
According to predictions issued at the Fed’s policy meeting in December, central bankers expect inflation to fall to 2.6 percent by the end of 2022 and 2.3 percent by the end of 2023.
Is inflation expected to fall in 2022?
Inflation increased from 2.5 percent in January 2021 to 7.5 percent in January 2022, and it is expected to rise even more when the impact of Russia’s invasion of Ukraine on oil prices is felt. However, economists predict that by December, inflation would be between 2.7 percent and 4%.
Is inflation likely to worsen?
If inflation stays at current levels, it will be determined by the path of the epidemic in the United States and overseas, the amount of further economic support (if any) provided by the government and the Federal Reserve, and how people evaluate future inflation prospects.
The cost and availability of inputs the stuff that businesses need to make their products and services is a major factor.
The lack of semiconductor chips, an important ingredient, has pushed up prices in the auto industry, much as rising lumber prices have pushed up construction expenses. Oil, another important input, has also been growing in price. However, for these inputs to have a long-term impact on inflation, prices would have to continue rising at the current rate.
As an economist who has spent decades analyzing macroeconomic events, I believe that this is unlikely to occur. For starters, oil prices have leveled out. For instance, while transportation costs are rising, they are not increasing as quickly as they have in the past.
As a result, inflation is expected to moderate in 2022, albeit it will remain higher than it was prior to the pandemic. The Wall Street Journal polled economists in early January, and they predicted that inflation will be around 3% in the coming year.
However, supply interruptions will continue to buffet the US (and the global economy) as long as surprises occur, such as China shutting down substantial sectors of its economy in pursuit of its COVID zero-tolerance policy or armed conflicts affecting oil supply.
We can’t blame any single institution or political party for inflation because there are so many contributing factors. Individuals and businesses were able to continue buying products and services as a result of the $4 trillion federal government spending during the Trump presidency, which helped to keep prices stable. At the same time, the Federal Reserve’s commitment to low interest rates and emergency financing protected the economy from collapsing, which would have resulted in even more precipitous price drops.
The $1.9 trillion American Rescue Plan passed under Biden’s presidency adds to price pressures, although not nearly as much as energy price hikes, specific shortages, and labor supply decreases. The latter two had more to do with the pandemic than with specific policies.
Some claim that the government’s generous and increased unemployment insurance benefits restricted labor supply, causing businesses to bid up salaries and pass them on to consumers. However, there is no proof that this was the case, and in any case, those advantages have now expired and can no longer be blamed for ongoing inflation.
It’s also worth remembering that inflation is likely a necessary side effect of economic aid, which has helped keep Americans out of destitution and businesses afloat during a period of unprecedented hardship.
Inflation would have been lower if the economic recovery packages had not offered financial assistance to both workers and businesses, and if the Federal Reserve had not lowered interest rates and purchased US government debt. However, those decreased rates would have come at the expense of a slew of bankruptcies, increased unemployment, and severe economic suffering for families.