A New Model of Trend Inflation

Joshua Chan, Gary Koop and Simon Potter

No 1202, Working Papers from University of Strathclyde Business School, Department of Economics

Abstract: This paper introduces a new model of trend (or underlying) inflation. In contrast to many earlier approaches, which allow for trend inflation to evolve according to a random walk, ours is a bounded model which ensures that trend inflation is constrained to lie in an interval. The bounds of this interval can either be fixed or estimated from the data. Our model also allows for a time-varying degree of persistence in the transitory component of inflation. The bounds placed on trend inflation mean that standard econometric methods for estimating linear Gaussian state space models cannot be used and we develop a posterior simulation algorithm for estimating the bounded trend inflation model. In an empirical exercise with CPI inflation we find the model to work well, yielding more sensible measures of trend inflation and forecasting better than popular alternatives such as the unobserved components stochastic volatility model.

Keywords: Constrained inflation; non-linear state space model; underlying inflation; inflation targeting; inflation forecasting; Bayesian (search for similar items in EconPapers)
JEL-codes: C11 C53 E31 E37 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2012-02
New Economics Papers: this item is included in nep-cba, nep-ets, nep-for, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Journal Article: A New Model of Trend Inflation (2013)
Working Paper: A New Model Of Trend Inflation (2012)
Working Paper: A New Model of Trend Inflation (2012)
Working Paper: A new model of trend inflation (2012)
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