Cleveland Fed researchers assess the likelihood of 2 percent inflation in the next three years
Since the recovery began in 2009:Q3, inflation as measured by the price index for personal consumption expenditures (PCE) has been below the Federal Reserve’s long-run objective of 2 percent. Recent forecasts from professional economists have inflation rising to 2 percent over the next two to three years. However, researchers at the Federal Reserve Bank of Cleveland say the likelihood that such a forecast will come to pass is less than 50 percent.
Ellis Tallman, a senior vice president and research director at the Cleveland Fed, and Saeed Zaman, an economist at the Bank, examine inflation forecasts from six statistical models that have historically performed well at forecasting inflation. They find that the models project generally rising inflation. However, they also find that five of the six models suggest less than a 50 percent probability that inflation will be 2 percent or higher over the next three years.
“To improve forecasting accuracy, the models we consider include stochastic volatility, or a time-varying standard deviation of the size of the shocks hitting the economy,” say the researchers. “An increasing body of research has shown that incorporating stochastic volatility into macroeconomic models improves the precision of both point and density forecasts of inflation.”
At the same time, the researchers note that in all of their model simulations, there are wide probability bands around the forecasts, indicating a considerable degree of uncertainty.
Federal Reserve Bank of Cleveland
The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the US central bank, the Cleveland Fed participates in the formulation of our nation’s monetary policy, supervises banking organizations, provides payment and other services to financial institutions and to the US Treasury, and performs many activities that support Federal Reserve operations System-wide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and educational activities.
The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.
Doug Campbell, email@example.com, 513.455.4479