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Decomposing household, professional and market forecasts on inflation: a dynamic factor model analysis

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  • Joseph Palardy
  • Tomi Ovaska

Abstract

A dynamic factor model with stochastic volatility is used to investigate the relationships between three alternative measures of inflation expectations. The results show evidence of both a common time-varying trend and a common transitory component between inflation and short-term inflation expectations from households, professionals and markets. While the common time-varying trend has declined in both level and volatility since the early 1980s, it was found that consumer expectations are disproportionately influenced by the visibility of prices of select few goods. Roughly speaking, a 1% point increase in food and energy prices leads to about 1/3% point increase in consumer forecasts of inflation. In terms of policymaking, this finding suggests that stability in highly visible prices can moderate inflation in a meaningful way.

Suggested Citation

  • Joseph Palardy & Tomi Ovaska, 2015. "Decomposing household, professional and market forecasts on inflation: a dynamic factor model analysis," Applied Economics, Taylor & Francis Journals, vol. 47(20), pages 2092-2101, April.
    • Handle: RePEc:taf:applec:v:47:y:2015:i:20:p:2092-2101
    DOI: 10.1080/00036846.2014.1002889
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    References listed on IDEAS

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    1. Marco Del Negro & Christopher Otrok, 2008. "Dynamic factor models with time-varying parameters: measuring changes in international business cycles," Staff Reports 326, Federal Reserve Bank of New York.
    2. Dean Croushore, 1997. "The Livingston Survey: still useful after all these years," Business Review, Federal Reserve Bank of Philadelphia, issue Mar, pages 15-27.
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    Cited by:

    1. Niu, Xiaoxiao & Harvey, Nigel, 2023. "Are lay expectations of inflation based on recall of specific prices? If so, how and under what conditions?," Journal of Economic Psychology, Elsevier, vol. 98(C).
    2. James Yetman, 2022. "What's Up with Inflation Expectations?," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 55(1), pages 136-140, March.
    3. Claudio Borio & Marco Jacopo Lombardi & James Yetman & Egon Zakrajsek, 2023. "The two-regime view of inflation," BIS Papers, Bank for International Settlements, number 133, July.
    4. Niu, Xiaoxiao & Harvey, Nigel, 2022. "Context effects in inflation surveys: The influence of additional information and prior questions," International Journal of Forecasting, Elsevier, vol. 38(3), pages 988-1004.

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