We have updated our 11 trend-inflation models through 2021:Q4 to reflect news on survey-based measures of long-term inflation expectations, as well as a revised path of slack (unemployment gap) and other supply-side relevant variables.
Results
The inclusion of the fourth quarter has resulted in an additional upward tick of the mean across models, following a steady increase in the last three quarters. The models now suggest that trend inflation is a bit above the Fed target. The average across all models (the solid black line in Figure 1 below) is estimated at 2.3 percent in 2021:Q4, 4 tenths higher than the pre-Covid.
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 Q4 has triggered upward revisions even for the most persistent models (the TVP-VARs). Needless to say, the usual disclaimer about the end-of-sample uncertainty applies.
Implications for the Fed staff
The estimated average across models can be taken as one of the three ways to estimate underlying inflation or pi* (the other two being the evidence from long-term inflation expectations, and the general equilibrium approach considering 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. We continue to believe that the staff has set pi* to 1.8 percent, flat in history and in the forecast (the black dashed line in Figure 1). As such, the evidence from the trend models continues to signal 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 2021:Q4. The “Average” line is calculated as a simple mean across all models.