We have updated our 11 trend-inflation models through 2022:Q1 to reflect our nowcast for core PCE price inflation, as well as incoming data on long-term inflation expectations, the unemployment rate and other supply-side relevant variables.
Results
The inclusion of the first quarter has resulted in an additional upward tick of the mean across models, following a steady increase last year. The models now suggest that trend inflation is well above the Fed target. The average across all models (the solid black line in Figure 1 below) is estimated at 2.7 percent in 2022:Q1. As a comparison, at the time of the January 2022 FOMC the models were suggesting 2.3 percent (in 2021:Q4).
Comment
It is not a surprise that most measures of trend inflation are revising up their estimates in reaction to high incoming data, given the size of the shock. Nevertheless, the inclusion of 2022:Q1 has triggered upward revisions even in the most persistent models (the TVP-VARs), which are now well above 3 percent. The models that remain close to the Fed target are the Phillips-curve models with survey-based long-term expectations which have remained broadly stable in recent months.
Implications for the Fed staff
The average across models is one of the three ways to estimate underlying inflation or pi* (the other two are long-term inflation expectations and the general equilibrium approach which considers the interaction between pi* and U*). As a reminder: the level and evolution of pi* is the crucial assumption in the Fed staff framework/forecast and it is possibly the single most important variable for monetary policy. According to the FOMC minutes, the Fed staff is currently assuming that pi* gradually converges to 2 percent at the end of the medium-term. As such, the evidence from the trend models now signals significant upside risks to the medium-term Fed staff forecast.
Figures and Tables
Figure 1
Note: the chart shows the estimated trend inflation from 11 econometric models. The models are split into three groups. The first group is a collection of Phillips-curve (PC) type of trend inflation models in which a measure of long-term inflation expectations is used as a proxy of trend inflation. The second group is a collection of state-space unobserved component models in which we have modelled trend inflation either as a smooth trend or as an augmented local level. Finally, the third group of models is a collection of Time Varying Parameters Vector AutoRegressive models (TVP-VAR) with different endogenous variables. This set of models follows the FEDS Note by Rudd (2020) “Underlying Inflation: Its Measurement and Significance”. The Fed staff assumption about the level of underlying inflation (set at 1.8 percent) is inferred from Laubach et al. (2014) “Long-term Inflation Expectations and Risks to the Inflation Outlook“.
Table 1
Note: the 70% confidence intervals refer to 2022:Q1. The “Average” line is calculated as a simple mean across all models.