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Exact prediction of inflation in the USA

  • Ivan, Kitov

A linear and lagged relationship between inflation and labor force growth rate has been recently found for the USA. It accurately describes the period after the late 1950s with linear coefficient 4.0, intercept -0.03, and the lag of 2 years. The previously reported agreement between observed and predicted inflation is substantially improved by some simple measures removing the most obvious errors in the labor force time series. The labor force readings originally obtained from the Bureau of Labor Statistics (BLS) website are corrected for step-like adjustments. Additionally, a half-year time shift between the inflation and the annual labor force readings is compensated. GDP deflator represents the inflation. Linear regression analysis demonstrates that the annual labor force growth rate used as a predictor explains almost 82% (R2=0.82) of the inflation variations between 1965 and 2002. Moving average technique applied to the annual time series results in a substantial increase in R2. It grows from 0.87 for two-year wide windows to 0.96 for four-year windows. Regression of cumulative curves is characterized by R2>0.999. This allows effective replacement of GDP deflation index by a “labor force growth” index. The linear and lagged relationship provides a precise forecast at the two-year horizon with root mean square forecasting error (RMSFE) as low as 0.008 (0.8%) for the entire period between 1965 and 2002. For the last 20 years, RMSFE is only 0.4%. Thus, the forecast methodology effectively outperforms any other forecasting technique reported in economic and financial literature. Moreover, further significant improvements in the forecasting accuracy are accessible through improvements in the labor force measurements in line with the US Census Bureau population estimates, which are neglected by BLS.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 2735.

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Date of creation: Jul 2006
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Handle: RePEc:pra:mprapa:2735
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  1. Ivan O. Kitov, 2008. "GDP growth rate and population," Papers 0811.2125, arXiv.org.
  2. Sbordone, Argia, 1998. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Seminar Papers 653, Stockholm University, Institute for International Economic Studies.
  3. Ivan Kitov, 2007. "The Japanese Economy," Mechonomics mechonomics6, Socionet.
  4. Hubrich, Kirstin, 2003. "Forecasting euro area inflation: Does aggregating forecasts by HICP component improve forecast accuracy?," Working Paper Series 0247, European Central Bank.
  5. Stock, James H. & Watson, Mark W., 1999. "Forecasting inflation," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 293-335, October.
  6. Ivan O. Kitov, 2006. "Inflation, unemployment, labor force change in the USA," Working Papers 28, ECINEQ, Society for the Study of Economic Inequality.
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