Tuesday, May 30, 2017

Checking in on some forecasts of core PCE inflation

The US core PCE inflation numbers for April were released this morning. The major deviation for March ended up being revised a bit (from −1.7% to −1.6% for the continuously compounded annual rate of change) and the April number is more in line with the past data (+1.8%). All of these are basically in line with the dynamic equilibrium model NGDP L:

The old forecast versus the FRBNY DSGE model for the past three years that I promised to update still looks like it is undershooting on average: 

These two different models (the former dynamic equilibrium and the latter monetary model) are actually incompatible with each other [1] but in a way that is interesting. The monetary model sees the fall of inflation over the past 30 or so years in the US as part of a long term trend towards zero. The dynamic equilibrium model sees that same fall as the receding demographic shock of the 1970s and 80s, recently returning to the "normal" inflation rate of about 1.7%.

In the monetary model, the ansatz for the changing information transfer index is seen as only an approximation in terms of the partition function approach which itself (given its definition in terms of well-defined growth rates) is more compatible with the dynamic equilibrium model. 

In fact, the poor performance of the monetary model roughly since 2016 was in the back of my mind when I wrote my post from yesterday where I made the bold claim that "money is unimportant".

As is typical for macro models it hasn't been rejected yet at any respectable p-value. But it probably isn't useful. Per my back and forth with Narayana Kocherlakota, it is close to being out-performed by a constant model (although it only has three parameters, so according to various information criteria it is still out-performing the FRBNY DSGE model that has at least 10 parameters despite it having a lower RMS error).

Unless core PCE inflation takes a dive over the next several months, I'll probably have to add a sad face to the forecast archive.



[1] They can be made to be compatible, but in the light of this post I may want to give up on this inflation model. 

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