Inflation Nowcasting

Nowcasting is a combination of two terms: “now” and “forecasting.” Economic indicators are often released with a considerable delay, but there is usually intense interest in knowing what a given indicator is before its official release. Nowcasting refers to the prediction of the present, the very recent past, and the very near future—in essence, trying to fill in that missing data point with an accurate estimate. Often, nowcasts take advantage of higher-frequency data that are informative about some other economic indicator to predict what the next release of the indicator of interest will say.

Inflation is a topic of perennial interest because it influences the behavior and plans of consumers, businesses, financial markets, pension funds, governments—in essence, everyone in an economy. The Federal Reserve pays close attention to inflation because of its impact on the economy and because the Federal Open Market Committee has been explicitly tasked by Congress through the Federal Reserve Act to promote the goals of maximum employment and price stability, the so-called “dual mandate.” When making decisions, consumers and businesses may have to forecast the inflation rate far into the future. For example, if a consumer is thinking about taking out a loan, it helps to know how quickly wages and prices will be rising during the life of the loan—after all, it will be much easier to service the loan with stronger wage and price growth. Unfortunately, inflation tends to be difficult to predict accurately. But some recent research finds that forecasts of inflation in the future can be improved by having more accurate estimates of near-term inflation, or nowcasts. These nowcasts serve as an important jumping-off point for thinking about where inflation will be in the future.

We generate nowcasts for four inflation measures: (1) inflation in the price index for personal consumption expenditures, more commonly referred to as PCE inflation; (2) inflation in the PCE price index excluding food and energy, also known as core PCE inflation; (3) inflation in the consumer price index (CPI); and (4) inflation in the CPI excluding food and energy, also known as core CPI inflation. The model reports seasonally adjusted, month-over-month inflation rates in these four measures (expressed as nonannualized percent changes) and quarterly inflation rates in these four measures (expressed at seasonally adjusted annualized rates, or SAAR). The model also reports year-over-year inflation rates in these four measures (based on nonseasonally adjusted data for CPI inflation and core CPI inflation and seasonally adjusted data for PCE inflation and core PCE inflation).

Using historical comparisons from 1999 to 2015, inflation nowcasts from the Cleveland Fed’s model have been highly accurate. Our model’s nowcasts easily outperform a variety of nowcasts from alternative statistical models, especially over the course of a month or quarter. But perhaps even more notable is the model’s performance compared with the best available benchmarks: nowcasts from surveys of professional forecasters. The model’s nowcasts for CPI inflation tend to be more accurate than the consensus (average) nowcasts from the Blue Chip Economic Indicators survey. Its nowcasts for CPI and PCE inflation also tend to be more accurate than the median nowcasts from the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters (SPF). These results are somewhat surprising, because professional forecasters can and do use a range of models and judgment to capture the special factors that affect near-term inflation trends, and there is additionally evidence of the wisdom of the masses (or, more formally, the law of large numbers) when making forecasts. Meanwhile, the model’s nowcasts for core inflation tend to be just as accurate as those in the SPF, but the model is available at a daily frequency, while the SPF is released only once per quarter.

Finally, we also compare the model’s inflation nowcasting accuracy with publicly available nowcasts from the Greenbook (the in-depth analysis of economic conditions produced by the Federal Reserve Board of Governors staff for Federal Open Market Committee meetings). While Greenbook nowcasts tend to be highly accurate, they are only released to the public with a five-year lag. The Cleveland Fed’s model nowcasts have historically tended to be quite similar to those in the Greenbook, but they are available in real time, without delay.

Yes, every business day around 10:00 a.m. Eastern time.

In the United States, the Bureau of Labor Statistics (BLS) typically releases the CPI for a given month around the middle of the following month (for example, the January CPI is released around mid-February). The Bureau of Economic Analysis (BEA) typically releases the other major measure of consumer prices, the PCE price index, around the end of the following month (for example, the January PCE price index is released around the end of February, after the CPI for January has been released).

Daily Brent crude spot oil prices and weekly retail gasoline prices.

The nowcasts are produced using ten data series. Eight data series are monthly. Five of these monthly series come from the BLS: the CPI, the core CPI, the CPI for food, the CPI for food at home, and the CPI for gasoline. (All of the CPI series we use are seasonally adjusted.) Three of the monthly series come from the BEA: the PCE price index, the core PCE price index, and the PCE price index for food and beverages purchased for off-premises consumption. One data series is weekly: retail gasoline prices, released each Monday by the Energy Information Administration. One data series is daily: Brent crude spot oil prices, from the Financial Times or the Energy Information Administration.

In a nutshell, there are four parts to the model. The first part nowcasts (or, perhaps more accurately, forecasts) core inflation. To do so, we find that estimates based entirely on the recent past do a fairly good job. The second part forecasts food price inflation. Again, we primarily use the recent past to forecast future food price inflation. The third part nowcasts gasoline price inflation. We use a combination of current gasoline prices and current oil prices, under the assumption that today’s oil prices are informative about where gasoline prices are likely to head in the future, and then we seasonally adjust the data. Finally, the fourth part combines the nowcasts and forecasts of core inflation, food price inflation, and gasoline price inflation to come up with nowcasts of inflation in either the CPI or PCE price index.

Nowcasts change when new data arrive that are different than what was expected. This can be either because of the frequency with which new data arrive or the volatility of that new data.

The core inflation nowcasts use very few data sources, which arrive infrequently; therefore, they only change infrequently. Nowcasts of core CPI inflation are based only on past core CPI inflation; thus, the nowcasts can only change when new CPI data are released (or when past data are revised). However, if the data come in exactly as expected, then the core CPI inflation nowcasts will not actually change. Nowcasts of core PCE inflation are primarily based on past core PCE inflation, but they can also be affected by the availability of CPI data: if we have one more core CPI observation than core PCE for some month t, then we map month t’s core CPI observation to core PCE in month t. Thus, core PCE nowcasts can only change when we get new data on either the CPI or the PCE price index—but again, if the data come in exactly as expected, they actually will not change.

Core inflation also tends to be relatively stable, so revisions to core inflation nowcasts can be small when they do occur. By contrast, gasoline prices play an important role in headline CPI and PCE inflation nowcasts, and gasoline price nowcasts depend in turn on oil prices. Oil prices move around almost every day, and they can be quite volatile and thus difficult to predict. The headline inflation nowcasts can change when new CPI or PCE price index data are released; but between releases, they often move around based on incoming oil and gasoline price data.

Nowcasts are a type of forecast and thus are always subject to considerable uncertainty and imprecision. After all, we are using a very small number of series (ten) and simple statistical techniques to make informed guesses about economic indicators before they are released. By contrast, the official data releases are usually the product of tens of thousands of observations, powerful computational techniques, and a very large number of hours worked. On average, the model’s nowcasts tend to be more precise than a range of competing nowcasts, but the outperformance is not absolute. The accuracy of each individual nowcast depends on a range of factors, including the measure under consideration and the point in the month or quarter that the nowcast is being made. On average, nowcasts made with more information later in a month or quarter tend to be more accurate. But shocks are ever-present that can push inflation away from the nowcasted value, especially if they occur to inflation components that we do not try to model.

The charting tool on the nowcasting website allows you to plot a sequence of nowcasts for previous months or quarters along with the actual inflation release (for simplicity, we display the first available data release corresponding to the quarter or month being nowcasted). This allows the user to see how close or far the model’s nowcasts were compared with what was actually released by the statistical agency (the BLS or the BEA). Typically, nowcasts early in the month or quarter are less precise than nowcasts made later in the month or quarter, because the early nowcasts are based on less information than later nowcasts.

We are constantly seeking ways to improve this website and its functionality. One item on the to-do list is to provide an option that includes historical nowcasting error bands in the charts that vary with the exact information set available at a given point in time. These bands would start out wide at the beginning of a month or quarter and then shrink over time as more information accumulates.

Yes, the basic model is the same, but there is one difference. The paper uses a single series on food inflation (specifically, the CPI for food) in constructing both CPI and PCE inflation estimates. On the website, the PCE inflation estimates are constructed using a different measure of food inflation—inflation in the PCE price index for food and beverages purchased for off-premises consumption.

This change is methodologically more consistent with how the PCE price index is constructed, and it would have been great to include it in the paper. But unfortunately, a long real-time history of this particular series is not available.

After deciding to include the PCE price index for food and beverages purchased for off-premises consumption, we added one more series to the model—the CPI for food at home. Monthly inflation in the CPI for food at home has historically been similar to monthly inflation in the PCE price index for food and beverages purchased for off-premises consumption. As a result, the CPI for food at home can provide some additional information at times about the PCE price index for food and beverages purchased for off-premises consumption.

In this document, we very quickly go through the key elements of the model used to compute the inflation nowcasts, focusing more on practical implementation than technical details. For technical detail on the model, see the working paper.