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Trend inflation in advanced economies

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  • Christine Garnier
  • Elmar Mertens
  • Edward Nelson

Abstract

We derive estimates of trend inflation for fourteen advanced economies from a framework in which trend shocks exhibit stochastic volatility. The estimated specification allows for time-variation in the degree to which longer-term inflation expectations are well anchored in each economy. Our results bring out the effect of changes in monetary regime (such as the adoption of inflation targeting in several countries) on the behavior of trend inflation. Our estimates expand on the previous literature in several dimensions: For each country, we employ a multivariate approach that pools different inflation series in order to identify their common trend. In addition, our estimates of the inflation gap—defined as the difference between trend and observed inflation—are allowed to exhibit considerable persistence. Consequently, the fluctuations in estimates of trend inflation are much lower than those reported in studies that use stochastic volatility models in which inflation gaps are serially uncorrelated. This specification also makes our estimates less sensitive than trend estimates in the literature to the effect of distortions to inflation arising from non-market influences on prices, such as tax changes. A forecast evaluation based on pseudo-real-time estimates documents improvements in inflation forecasts, even though it remains hard to outperform simple random walk forecasts to a statistically significant degree.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2013-74.

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Date of creation: 2013
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Handle: RePEc:fip:fedgfe:2013-74

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  1. Robert J. Gordon, 1982. "Wages and Prices Are Not Always Sticky: A Century of Evidence for the United States, United Kingdom, and Japan," NBER Working Papers 0847, National Bureau of Economic Research, Inc.
  2. Peter N. Ireland, 2005. "Changes in the Federal Reserve's inflation target: causes and consequences," Working Papers 05-13, Federal Reserve Bank of Boston.
  3. Frye, Jon & Gordon, Robert J, 1981. "Government Intervention in the Inflation Process: The Econometrics of "Self-Inflicted Wounds"," American Economic Review, American Economic Association, vol. 71(2), pages 288-94, May.
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  8. Katharine Neiss & Edward Nelson, 2002. "Inflation dynamics, marginal cost, and the output gap: evidence from three countries," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  9. Andrea Carriero & Todd E. Clark & Massimiliano Marcellino, 2012. "Common drifting volatility in large Bayesian VARs," Working Paper 1206, Federal Reserve Bank of Cleveland.
  10. James H. Stock & Mark W. Watson, 2007. "Erratum to "Why Has U.S. Inflation Become Harder to Forecast?"," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(7), pages 1849-1849, October.
  11. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 253-63, July.
  12. James H. Stock & Mark W.Watson, 2003. "Forecasting Output and Inflation: The Role of Asset Prices," Journal of Economic Literature, American Economic Association, vol. 41(3), pages 788-829, September.
  13. Timothy Cogley & Thomas J. Sargent, 2005. "Drift and Volatilities: Monetary Policies and Outcomes in the Post WWII U.S," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 262-302, April.
  14. Andrew Atkeson & Lee E. Ohanian., 2001. "Are Phillips curves useful for forecasting inflation?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-11.
  15. Sharon Kozicki & P. A. Tinsley, 2012. "Effective Use of Survey Information in Estimating the Evolution of Expected Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(1), pages 145-169, 02.
  16. Elmar Mertens, 2011. "Measuring the level and uncertainty of trend inflation," Finance and Economics Discussion Series 2011-42, Board of Governors of the Federal Reserve System (U.S.).
  17. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, vol. 7(2), pages 151-174.
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