Real-Time Inflation Forecasting in a Changing World

59 Pages Posted: 3 Sep 2009 Last revised: 30 May 2012

See all articles by Jan J. J. Groen

Jan J. J. Groen

Federal Reserve Bank of New York

Richard Paap

Erasmus University Rotterdam (EUR) - Department of Econometrics; Tinbergen Institute; Erasmus Research Institute of Management (ERIM)

Francesco Ravazzolo

Free University of Bolzano

Date Written: May 25, 2012

Abstract

This paper revisits the accuracy of inflation forecasting using activity and expectations variables. We apply Bayesian model averaging across different regression specifications selected from a set of potential predictors that includes lagged values of inflation, a host of real activity data, term structure data, nominal data and surveys. In this model average we can entertain different channels of structural instability, either by incorporating stochastic breaks in the regression parameters of each individual specification within this average, allowing for breaks in the error variance of the overall model average, or both. Thus, our framework simultaneously addresses structural change and model uncertainty that would unavoidably affect any inflation forecast model. The different versions of our framework are used to model U.S. PCE deflator and GDP deflator inflation rates for the 1960-2011 period. A real-time inflation forecast evaluation shows that averaging over many predictors in a model that at least allows for structural breaks in the error variance results in very accurate point and density forecasts, especially for the post-1984 period. Our framework is especially useful when forecasting, in real-time, the likelihood of lower-than-usual inflation rates over the medium term.

Keywords: inflation forecasting, Phillips correlations, real-time data, structural breaks, model uncertainty, Bayesian model averaging

JEL Classification: C11, C22, C53, E31

Suggested Citation

Groen, Jan J. J. and Paap, Richard and Ravazzolo, Francesco, Real-Time Inflation Forecasting in a Changing World (May 25, 2012). FRB of New York Staff Report No. 388. Available at SSRN: https://ssrn.com/abstract=1465985 or http://dx.doi.org/10.2139/ssrn.1465985

Jan J. J. Groen (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

HOME PAGE: http://nyfedeconomists.org/groen/

Richard Paap

Erasmus University Rotterdam (EUR) - Department of Econometrics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Tinbergen Institute ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Francesco Ravazzolo

Free University of Bolzano ( email )

Bolzano
Italy

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