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The Real-time Forecasting Performance of Phillips Curves

  • Tim Robinson

    (Reserve Bank of Australia)

  • Andrew Stone

    (Reserve Bank of Australia)

  • Marileze van Zyl

    (Reserve Bank of Australia)

Analysts typically use a variety of techniques to forecast inflation. These include both ‘bottom-up’ approaches, for near-term forecasting, as well as econometric methods (such as mark-up models of inflation, which have been found to perform quite well for Australia – see de Brouwer and Ericsson (1998)). One of the econometric approaches to inflation forecasting which is sometimes considered is the use of Phillips curves based on estimates of the output gap. This paper suggests, however, that the real-time capacity of such Phillips curves to forecast inflation is limited, relative even to such simple benchmark forecasting approaches as an autoregressive (AR) model of inflation or a random walk assumption. It appears that the lack of precision with which output-gap-based Phillips curves can be estimated in real time limits their usefulness as a means of forecasting inflation in isolation. Phillips curve-based forecasts may, however, perform a little better than AR model-based ones in at least predicting whether inflation will increase or decrease from its current level. Moreover, combining Phillips curve-based forecasts with those from simple, alternative approaches does seem to offer some scope for improving the real-time forecast accuracy of the latter. These observations suggest that, in spite of their generally disappointing performance as a means of forecasting inflation in isolation, output-gap-based Phillips curves may continue to be useful in real time – as a tool for conditioning gap estimates within a multivariate filtering framework, and as a possible complement to other, alternative inflation forecasting approaches.

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Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2003-12.

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Date of creation: Dec 2003
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Handle: RePEc:rba:rbardp:rdp2003-12
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  1. Athanasios Orphanides & Simon van Norden, 1999. "The Reliability of Output Gap Estimates in Real Time," Macroeconomics 9907006, EconWPA.
  2. West,K.D., 1999. "Encompassing tests when no model is encompassing," Working papers 36, Wisconsin Madison - Social Systems.
  3. Holden, K & Peel, D A, 1990. "On Testing for Unbiasedness and Efficiency of Forecasts," The Manchester School of Economic & Social Studies, University of Manchester, vol. 58(2), pages 120-27, June.
  4. Christopher A. Sims, 2002. "The Role of Models and Probabilities in the Monetary Policy Process," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 1-62.
  5. Chong, Yock Y & Hendry, David F, 1986. "Econometric Evaluation of Linear Macro-Economic Models," Review of Economic Studies, Wiley Blackwell, vol. 53(4), pages 671-90, August.
  6. David Gruen & Adrian Pagan & Christopher Thompson, 1999. "The Phillips Curve in Australia," RBA Research Discussion Papers rdp1999-01, Reserve Bank of Australia.
  7. David Gruen & Tim Robinson & Andrew Stone, 2002. "Output Gaps in Real Time: Are They Reliable Enough to Use for Monetary Policy?," RBA Research Discussion Papers rdp2002-06, Reserve Bank of Australia.
  8. Meredith Beechey & Nargis Bharucha & Adam Cagliarini & David Gruen & Christopher Thompson, 2000. "A Small Model of the Australian Macroeconomy," RBA Research Discussion Papers rdp2000-05, Reserve Bank of Australia.
  9. Andrew Stone & Sharon Wardrop, 2002. "Real-time National Accounts Data," RBA Research Discussion Papers rdp2002-05, Reserve Bank of Australia.
  10. Edward Nelson & Kalin Nikolov, 2001. "UK inflation in the 1970s and 1980s: the role of output gap mismeasurement," Bank of England working papers 148, Bank of England.
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