Inflation dynamics and forecast : frequency matters

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Title: Inflation dynamics and forecast : frequency matters
Author: Martins, Manuel M. F. ; Verona, Fabio
Organization: Bank of Finland
Series: Bank of Finland Research Discussion Papers
Series number: 8/2021
Year of publication: 2021
Publication date: 8.6.2021
Pages: 49
Subject (yso): inflaatio; odotukset; ennusteet; mallit (tehtävä); työttömyys; energia; hinnat
Keywords: NKPC; Phillipsin käyrä
JEL: C53; E31; E37
Other keywords: inflation dynamics; inflation forecast; New Keynesian Phillips Curve; frequency domain; wavelets
Abstract: Policymakers and researchers see inflation characterized by cyclical fluctuations driven by changes in resource utilization and temporary shocks, around a trend influenced by inflation expectations. We study the in-sample inflation dynamics and forecast inflation out-of-sample by analyzing a New Keynesian Phillips Curve (NKPC) in the frequency domain. In-sample, while inflation expectations dominate medium-to-long-run cycles, energy prices dominate short cycles and business-to-medium cycles once expectations became anchored. While statistically significant, unemployment is not economically relevant for any cycle. Out-of-sample, forecasts from a low-frequency NKPC significantly outperform several benchmark models. The long-run component of unemployment is key for such remarkable forecasting performance.

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