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Does past inflation predict the future?

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Forecasts of non-tradables inflation have been produced using Phillips curves, where capacity pressure and inflation expectations have been the key drivers. The Bank had previously used the survey of 2-year ahead inflation expectations in its Phillips curve. However, from 2014 non-tradables inflation was weaker than the survey and estimates of capacity pressure suggested. Bank research indicated the weakness in non-tradables inflation may have been linked to low past inflation and its impact on pricing behaviour. This note evaluates whether measures of past inflation could have been used to produce forecasts of inflation that would have been more accurate than using surveys of inflation expectations. It does this by comparing forecasts for annual non-tradablesinflation one year ahead. Forecasts are produced using Phillips curves that incorporate measures of past inflation or surveys of inflation expectations, and other information available at the time of each Monetary Policy Statement (MPS). This empirical test aims to determine the approach that captures pricing behaviour best, highlighting which may be best for forecasting going forward. The results show that forecasts constructed using measures of past inflation have been more accurate than using survey measures of inflation expectations, including the 2-year ahead survey measure previously used by the Bank. In addition, forecasts constructed using measures of past inflation would have been significantly more accurate than the Bank’s MPS forecasts since 2009, and only slightly worse than these forecasts before the global financial crisis (GFC). The consistency of forecasts using past-inflation measures reduces the concern that this approach is only accurate when inflation is low, and suggests it may be a reasonable approach to forecasting non-tradables inflation generally. From late 2015, the Bank has assumed that past inflation has affected domestic price-setting behaviour more than previously. As a result, monetary policy has needed to be more stimulatory than would otherwise be the case. This price-setting behaviour is assumed to persist, and is consistent with subdued non-tradables inflation and low nominal wage inflation in 2017.

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  • Chris McDonald, 2017. "Does past inflation predict the future?," Reserve Bank of New Zealand Analytical Notes series AN2017/04, Reserve Bank of New Zealand.
    • Handle: RePEc:nzb:nzbans:2017/04
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    References listed on IDEAS

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    1. Kamber, Gunes & McDonald, Chris & Sander, Nick & Theodoridis, Konstantinos, 2016. "Modelling the business cycle of a small open economy: The Reserve Bank of New Zealand's DSGE model," Economic Modelling, Elsevier, vol. 59(C), pages 546-569.
    2. Özer Karagedikli & C. John McDermott, 2018. "Inflation expectations and low inflation in New Zealand," New Zealand Economic Papers, Taylor & Francis Journals, vol. 52(3), pages 277-288, September.
    3. David Hargreaves & Hannah Kite & Bernard Hodgetts, 2006. "Modelling New Zealand inflation in a Phillips curve," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 69, September.
    4. Neroli Austin & Geordie Reid, 2017. "NZSIM: A model of the New Zealand economy for forecasting and policy analysis," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 80, pages 1-14, January.
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    2. Adam Richardson, 2019. "New Zealand Wage Inflation Post-crisis," RBA Annual Conference Papers acp2019-02, Reserve Bank of Australia, revised Jul 2019.
    3. Michael Callaghan & Thomas van Florenstein Mulder, 2020. "GDP Plus: An Economic Activity Indicator for New Zealand," Reserve Bank of New Zealand Analytical Notes series AN2020/01, Reserve Bank of New Zealand.
    4. Punnoose Jacob & Finn Robinson, 2019. "Suite as! Augmenting the Reserve Bank’s output gap indicator suite," Reserve Bank of New Zealand Analytical Notes series AN2019/08, Reserve Bank of New Zealand.
    5. Punnoose Jacob & Martin Wong, 2018. "Estimating the NAIRU and the Natural Rate of Unemployment for New Zealand," Reserve Bank of New Zealand Analytical Notes series AN2018/04, Reserve Bank of New Zealand.

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