Inflation Forecasting

By Stock, James H.; Watson, Mark W. | NBER Reporter, Spring 2012 | Go to article overview

Inflation Forecasting

Stock, James H., Watson, Mark W., NBER Reporter

Forecasting inflation is one of the core responsibilities of economists at central banks and in the private sector, and models of inflation dynamics play a central role in determining monetary policy. In this light, it is not surprising that there is a long and rich literature on inflation dynamics and inflation forecasting.

A recurring theme in this literature is the usefulness--or not--of the Phillips curve as a tool for forecasting inflation. Phillips (1) originally documented an inverse relation between the rates of wage inflation and unemployment in the United Kingdom. Samuelson and Solow (2) extended "Phillips' curve" to U.S. data and to price inflation. The Phillips curve remains at the core of modern specifications, which additionally include expectations of inflation, often use activity variables other than the unemployment rate, and incorporate sluggish inflation dynamics. Indeed, the central price determination equation in modern dynamic stochastic general equilibrium models, the New Keynesian Phillips Curve, is a direct descendant of the original Phillips curve, augmented to incorporate forward-looking inflation expectations and with a real activity measure serving as a proxy for real marginal cost.

This research summary reviews our work of the past fifteen years on inflation forecasting using small, stand-alone models. Most of this work revolves around the use of real economic activity to forecast inflation, to which we refer broadly as Phillips curve models, although other forecasting frameworks (such as incorporating monetary aggregates) are also considered.


Our research on inflation forecasting and inflation dynamics leads us to two broad conclusions. First, there are important regularities in the inflation-output relation. In particular, in the post-war United States, recessions are times of disinflation. This regularity was behind the deflation scares of 2002-3 and 2009-10. Figure 1 plots the rate of unemployment and the four-quarter rate of core PCE inflation for six U.S. slumps from 1960 to the present, labeled by the NBER-dated cyclical peak. The plotted rates are deviated from their values at the respective NBER-dated peak; the vertical axis is scaled so that all recessions have the same increase in the unemployment rate; and the horizontal axis is scaled so that the total time span is twice the time between the start of the recession and the peak of the unemployment rate. The mean paths of the unemployment rates and inflation are shown as dashed lines, and the dotted lines are [+ or -] one standard deviation bands (3). Over these six recessions and recoveries, by the time the unemployment rate peaks, inflation has fallen on average by 0.37 percentage points for each percentage point increase in the rate of unemployment.

Second, we conclude that despite this evident regularity, inflation dynamics and inflation forecasting models exhibit considerable instability. Such instability is unsurprising, given the substantial changes in monetary policy, unionization, globalization, and other aspects of the U.S. economy that are relevant to price-setting. Indeed, Figure 1 suggests one important aspect of this instability: the rate of inflation fell by less following the NBER-dated peaks of 2001Q1 and 2007Q2 than it did on average during earlier the previous five recessions. A leading explanation for the more muted response of inflation over the two recent recessions is that monetary policy has succeeded in anchoring inflationary expectations. However, because both disinflationary episodes started at low levels, another candidate explanation is resistance to nominal wage declines.

Time Variation in Inflation Forecasting Models

The first step towards handling instability is admitting that you have a problem. Providing formal statistical evidence of instability entails the use of a variety of methods, including tests for in-sample breaks, tests for breaks at the end of the sample, and pseudo out-of-sample forecast comparisons.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Cite this article

Cited article

Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)


1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25,

Cited article

Inflation Forecasting


Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25,

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.