We have updated our trend-inflation models through 2021:Q3. Next update will include the final 2021:Q3 figures.
Results: The inclusion of the third quarter as well as a revised path for import prices and the unemployment gap has resulted in an upward revision of several models (both Q3 compared to Q2, and recent history).
The models continue to suggest that trend inflation is a bit above the Fed target. The average across all models (the solid black line in Figure A. below) is estimated at 2.2 percent in 2021:Q3, 3 tenths higher than the pre-Covid.
Comment: it should not be 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, even the most persistent models (the TVP-VARs) are now close to or at target. Needless to say, the usual disclaimer about the end-of-sample uncertainty applies.
Implications for the Fed: the estimated average across trend 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. 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 A.). As such, the evidence from the trend models is currently signaling upside risks to the medium-term staff forecast.
As mentioned, we will update the trend models once 2021:Q3 will be final. In the meanwhile, we will circulate an email discussing the risks around pi*, as signaled from the trend models, long-term inflation expectations, and the general equilibrium approach.
Trend inflation models
Figure A. 11 Trend inflation models
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 B. 11 Trend inflation models
Note: the 70% confidence intervals refer to 2021:Q3. The “Average” line is calculated as a simple mean across all models.