Saturday, February 4, 2017

Worthwhile Canadian prediction comes true

[Vancouver home sales falling] is not the result of a "bubble bursting" - this is Bank of Canada failing to deliver on its 2% inflation target.

In my prediction, I said that Canada would start to undershoot its inflation target due to factors beyond the control of the central bank. Here's me:
I'm going to put forward a prediction, using the information transfer model, that Canada will either undershoot its inflation targets or will have produced significantly more currency than the current log-linear trend. ... The interesting thing about this prediction is that it should start to become apparent by the end of next year (Dec 2015).
Well, the currency (monetary base) is right at its log-linear trend. So where is CPI? Well below that 2% trend ...


This undershooting effect is exactly as expected for an ensemble average of markets as presented in my paper:


This is a pretty big success. The US was already undershooting an implicit inflation target back in 2014, so saying Canada will start to undershoot in the future is a genuine test of the theory. Additionally, the reason for the undershooting has nothing to do with monetary policy ‒ there are simply more ways a complex economy can be organized as many low growth markets than as a few high growth markets. This means the former becomes the more likely state as an economy grows. A more thorough and technical explanation can be found here.

Update + 20 minutes

I would also like to say that this success is also a major failure of most other approaches from theories where central banks set expectations, to quantity theories (well, unless they're modified quantity theories like the information equilibrium model), to Taylor rules. It's because this undershooting was predictable with zero weight placed on any of the actions of the central bank in the model.

3 comments:

  1. Bravo! I remember this one well.

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    Replies
    1. Thanks Tom. Added an update a few seconds ago ...

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  2. Your model is very interesting and possibly very enlightening, but perhaps I'm missing something. Wouldn't many more traditional quantity theorists say that Canada could've just loosened monetary policy?

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