N. Kundan Kishora and Evan F. Koenigb
Real-time forecasting of PCE inflation is most successful when headline inflation is stripped of high-frequency noise and core inflation's trend and cycle are separately forecasted. It proves helpful, additionally, to allow cyclical inflation to respond to labor market slack, to allow for a late-1990s break in the behavior of trend inflation, and to explicitly model revisions to headline inflation. We do all of this within the context of an unobserved-common-components model of inflation and slack. The model's real-time inflation forecasts are significantly more accurate than those generated by benchmark models. That outperformance and the finding that cyclical inflation responds to slack are robust to an alternative measure of slack, an alternative model of trend inflation, and an alternative treatment of data revisions.
JEL Code: E31, E37.
Full article (PDF, 38 pages)
a University of Wisconsin-Milwaukee
b Federal Reserve Bank of Dallas