What the paper does
The authors look at the behavior of sticky-prices (CPI) inflation and argue that it has forecasting properties for CPI itself. The paper follows two steps. First, it constructs a measure of sticky-prices inflation that corrects for base effects (a weighted average of last 2 months of data – monthly observations at annual rate). Second, they regress future changes in CPI inflation on the gap between current sticky-price inflation and CPI inflation itself (the intuition is that a unity coefficient in this regression implies that sticky-price inflation acts as an anchor for future inflation).
Using the authors’ favorite metric of inflation, in October sticky-prices inflation was above 5% (the Trimmed mean was around 8% and the median CPI was around 6.5%). Importantly, the authors also find a high coefficient in the estimated regression (close to unity at 12 months horizon).
The analysis is not particularly sophisticated but the evidence is useful because sticky prices can only be optimized infrequently, so price setters are typically more forward looking than those setting flexible prices. In this sense, sticky price inflation may help anticipate future CPI inflation. A deeper analysis (i.e., correcting for Covid distortions as in out CI-C model or as in Shapiro (2020) model) would be necessary before reaching a conclusion. Nevertheless, the evidence of the authors is pretty clear and points in the direction this is not a one-time level shift due to the specificity of the Covid-shock but it is the beginning of a period of high inflation.
Implications for the Fed staff
The authors’ results are another evidence that the risks around the Fed staff inflation forecast are skewed to the upside, at least for another 12-24 months. In our view, the Fed staff will continue to assume that underlying inflation has not been influenced by the recent high readings for at least another 4-6 months. As such, we do not think the staff will materially change the forecast for 2022 at the December or January rounds (any change will be more cosmetic than substantial). However, the more the time goes by, the more evidence piles up against the staff which is running out of room. In our view, we continue to think that inflation will remain above target in 2022 (2.3% Q4/Q4), although we recognize that the risks around our own forecast might be skewed a bit to the upside.