Inflation Dynamics and Forecast: Frequency Matters

Abstract

We use a New Keynesian Phillips Curve (NKPC) to study in-sample inflation dynamics and to forecast inflation out-of-sample in the frequency domain. In-sample, inflation expectations dominate medium-to-long-run cycles, energy inflation dominate short cycles and also longer cycles once expectations became anchored. While statistically significant, unemployment is never economically relevant. Out-of-sample, forecasts from a low-frequency NKPC significantly outperform several benchmark models. The low-frequency component of unemployment is key for such remarkable forecasting performance. Hence, while unemployment is of little relevance in-sample, it remains crucial in predicting inflation out-of-sample due to its role at cycles longer than typical business cycles.

JEL Classification: C53, E31, E37