Inflation as a Global Phenomenon—Some Implications for Inflation Modelling and Forecasting

Abstract

We model local inflation dynamics using global inflation and domestic slack motivated by a novel interpretation of the implications of the workhorse open-economy New Keynesian model. We evaluate the performance of inflation forecasts based on the single-equation forecasting specification implied by the model, exploiting the spatial pattern of international linkages underpinning global inflation. We find that incorporating crosscountry interactions yields significantly more accurate forecasts of local inflation for a diverse group of 14 advanced countries (including the U.S.) than either a simple autoregressive model or a standard closedeconomy Phillips curve-based forecasting model. We argue that modelling the temporal dimension-but not the crosscountry spillovers-of inflation does limit a model's explanatory power in-sample and its (pseudo) out-of-sample forecasting performance. Moreover, we also show that global inflation (without domestic slack) often contributes the most to achieve the gains on forecasting accuracy observed during our sample period (1984:Q1-2015:Q1)-this observation, according to theory, is crucially related to the flattening of the Phillips curve during this time period of increased globalization.

New perspectives on forecasting inflation in emerging market economies: An empirical assessment

“…As in Kabukcuoglu and Martínez-García (2018), we abstract from the changes in the Phillips curve functional form arising when the Calvo (1983) pricing equation is log-linearized around a non-zero in ‡ation rate (discussed elsewhere by Ascari (2004) and Sahuc (2006)). The intertemporal discount factor is 0 < < 1, while the composite coe¢ cient k…”

“…Moreover, we show that there is signi…cant cross-country variation in the RW-AO's performance among EMEs in our sample-Turkey, in fact, does not feature as one of the countries where we uncover the stronger statistical signi…cance in favor of the RW-AO model. advanced economies (as seen in Duncan and Martínez-García (2015) and Kabukcuoglu and Martínez-García (2018)).…”

“…The more recent literature, in turn, casts the Phillips curve and its predictions on a more positive light among advanced economiese.g. Ball and Mazumder (2014) and Coibion and Gorodnichenko (2015) considering the role of (anchored) in ‡ation expectations, and Duncan and Martínez-García (2015) and Kabukcuoglu and Martínez-García (2018) exploring the open-economy dimension of Phillips-curve-based models.…”

New Perspectives on Forecasting Inflation in Emerging Market Economies: An Empirical Assessment

“…As in Kabukcuoglu and Martínez-García (2018), we abstract from the changes in the Phillips curve functional form arising when the Calvo (1983) pricing equation is log-linearized around a non-zero in ‡ation rate (discussed elsewhere by Ascari (2004) and Sahuc (2006)). The intertemporal discount factor is 0 < < 1, while the composite coe¢ cient k (2017)).…”

Monetary Policy and Economic Performance Since the Financial Crisis

“…For example, the unemployment rate rose modestly in the first two years of 1990s and early 2000s economic expansions, making the labor market recovery from the GFC look especially strong relative to those episodes when measured from the start of the economic expansion rather than from the peak in the unemployment rate. By contrast, the unemployment rate fell 3.5 percentage points in the first year and a half following the 1981-82 recession, making the initial labor market recovery from the GFC look especially weak relative to that episode.3 More precisely, the labor force participation rate held steady, on net, from late 2013 until 2019, in contrast with the trend decline projected byAaronson et al (2014).4 For evidence on the role of longer-run inflation expectations and slack in determining realized inflation, seeBall and Mazumder (2011);Del Negro, Giannoni, and Schorfheide (2015);Duncan and Martínez-García (2015);Coibion and Gorodnichenko (2015);Yellen (2015); andKabukcuoglu and Martínez-García (2018).5 As of the writing of this article, 2014 is the latest calendar year for which Tealbook forecasts and FOMC memos are publicly available. In mid-2014, the staff also projected longer-run inflation expectations to eventually drift higher, pushing underlying inflation toward 2 percent, but acknowledged that such an upward drift was highly uncertain.6 See, for example,Aaronson et al (2015) andCairó and Cajner (2018).7 To some extent, a step-down in productivity growth following the information technology boom of the mid-1990s to early 2000s is unsurprising, though the extent and timing of that step-down were difficult to predict.…”