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Inflation: Do Expectations Trump the Gap?

Jeremy Piger () and Robert Rasche ()

International Journal of Central Banking, 2008, vol. 4, issue 4, 85-116

Abstract: We measure the relative contribution of the deviation of real activity from its equilibrium (the gap), “supply-shock” variables, and long-horizon inflation forecasts for explaining the U.S. inflation rate in the post-war period. For alternative specifications for the inflation-driving process and measures of inflation and the gap, we reach a similar conclusion: the contribution of changes in long-horizon inflation forecasts dominates that for the gap and supply-shock variables. Put another way, variation in long-horizon inflation forecasts explains the bulk of the movement in realized inflation. Further, we find evidence that long-horizon forecasts have become substantially less volatile over the sample period, suggesting that permanent shocks to the inflation rate have moderated. Finally, we use our preferred specification for the inflation-driving process to compute a history of model-based forecasts of the inflation rate. For both short and long horizons, these forecasts are close to inflation expectations obtained from surveys.

JEL-codes: C32 E31 (search for similar items in EconPapers)
Date: 2008
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Working Paper: Inflation: do expectations trump the gap? (2006) Downloads
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