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Inflation as a global phenomenon—Some implications for inflation modeling and forecasting

Ayşe Kabukçuoğlu and Enrique Martínez-García
Authors registered in the RePEc Author Service: Enrique Martínez García ()

Journal of Economic Dynamics and Control, 2018, vol. 87, issue C, 46-73

Abstract: We model local inflation dynamics using global inflation and domestic slack motivated by a novel interpretation of the implications of the workhorse open-economy New Keynesian model. We evaluate the performance of inflation forecasts based on the single-equation forecasting specification implied by the model, exploiting the spatial pattern of international linkages underpinning global inflation. We find that incorporating cross-country interactions yields significantly more accurate forecasts of local inflation for a diverse group of 14 advanced countries (including the U.S.) than either a simple autoregressive model or a standard closed-economy Phillips curve-based forecasting model. We argue that modeling the temporal dimension—but not the cross-country spillovers—of inflation does limit a model’s explanatory power in-sample and its (pseudo) out-of-sample forecasting performance. Moreover, we also show that global inflation (without domestic slack) often contributes the most to achieve the gains on forecasting accuracy observed during our sample period (1984:Q1-2015:Q1)—this observation, according to theory, is crucially related to the flattening of the Phillips curve during this time period of increased globalization.

Keywords: Inflation dynamics; Open-economy Phillips curve; Forecasting (search for similar items in EconPapers)
JEL-codes: C21 C23 C53 F41 F47 F62 (search for similar items in EconPapers)
Date: 2018
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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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