Does a factor Phillips curve help? An evaluation of the predictive power for U.S. inflation

Published on May 1, 2011in Empirical Economics
· DOI :10.1007/S00181-010-0352-0
Dandan Liu5
Estimated H-index: 5
(KSU: Kent State University),
Dennis W. Jansen22
Estimated H-index: 22
(A&M: Texas A&M University)
This article evaluates various models’ predictive power for U.S. inflation rate using a simulated out-of-sample forecasting framework. The starting point is the traditional unemployment Phillips curve. We show that a factor Phillips curve model is superior to the traditional Phillips curve, and its performance is comparable to other factor models. We find that a factor AR model is superior to the factor Phillips curve model, and is the best bivariate or factor model at longer horizons. Finally, we investigate a New Keynesian Phillips curve model, and find that its forecasting performance dominates all other models at the longer horizons.
  • References (23)
  • Citations (4)
📖 Papers frequently viewed together
1 Author (Markus Roth)
1 Citations
3 Citations
7 Citations
78% of Scinapse members use related papers. After signing in, all features are FREE.
The New Keynesian Phillips Curve, as a structural model of inflation dynamics, has mostly been used to explain past inflation developments, but has hardly been used for forecasting purposes. We propose a method of forecasting inflation based on the present-value formulation of the hybrid New Keynesian Phillips Curve. To evaluate the forecasting performance of this model we compare it with forecasts generated from a traditional Phillips Curve and time series models at different forecast horizons....
27 CitationsSource
#1Dandan Liu (BGSU: Bowling Green State University)H-Index: 5
#2Dennis W. Jansen (A&M: Texas A&M University)H-Index: 22
Abstract The use of a small number of underlying factors to summarize the information from a much larger set of information variables is one of the new frontiers in forecasting. In prior work, the estimated factors have not usually had a structural interpretation and the factors have not been chosen on a theoretical basis. In this paper we propose several variants of a general structural factor forecasting model, and use these to forecast certain key macroeconomic variables. We make the choice o...
7 CitationsSource
#1Fabio Canova (UPF: Pompeu Fabra University)H-Index: 45
This paper compares the forecasting performance of some leading models of inflation for G-7 countries. We show that bivariate and trivariate models suggested by economic theory or statistical analysis are not much better than univariate ones. Phillips curve specifications fit well into this class. Improvements in both the MSE of the forecasts and turning point prediction are obtained with time-varying coefficients models, which exploit international interdependencies. The performance of the latt...
51 CitationsSource
#1Jeremy B. Rudd (Federal Reserve System)H-Index: 16
#2Karl Whelan (Financial Services Authority)H-Index: 25
The canonical inflation specification in sticky-price rational expectations models (the new-Keynesian Phillips curve) is often criticized on the grounds that it fails to account for the dependence of inflation on its own lags. In response, many recent studies have employed a "hybrid" sticky-price specification in which inflation depends on a weighted average of lagged and expected future values of itself, in addition to a driving variable such as the output gap. In this paper, we consider some s...
156 CitationsSource
#1Stephen G. Cecchetti (Brandeis University)H-Index: 50
#2Rita S. Chu (Brandeis University)H-Index: 1
Last. Charles Steindel (Federal Reserve Bank of New York)H-Index: 13
view all 3 authors...
Analysts seeking evidence of rising inflation often focus on the movements of a single indicator_an increase in the price of gold, for example, or a decline in the unemployment rate. But simple statistical tests reveal that such indicators, used in isolation, have very limited predictive power.
84 Citations
A number of researchers have recently argued that the new-Keynesian Phillips curve matches the empirical behavior of inflation well when the labor income share is used as a driving variable, but fits poorly when deterministically detrended output is used. The theoretical motivation for these results rests on the idea that the output gap--the deviation between actual and potential output--is better captured by the labor income share, in turn implying that central banks should raise interest rates...
77 CitationsSource
The New Keynesian sticky-price model has become increasingly popular for monetary-policy analysis. However, there have been conflicting results on the empirical performance of the model. In this paper, I attempt to reconcile these conflicting claims by examining various specifications of the model within the context of a single framework. I find that the New Keynesian model does not fit the U.S. data well; in particular, the model requires additional lags of inflation not implied by the model un...
117 CitationsSource
This paper investigates the predictions of a simple optimizing model of nominal price rigidity for the aggregate price level and the dynamics of inflation. I compare the model's predictions with those of a perfectly competitive, flexible price `benchmark' model (corresponding to the model of pricing assumed in standard real business cycle models), and evaluate how much the introduction of nominal rigidities improves the model's fit with the data. The model's predictions are derived using only th...
639 CitationsSource
#1James H. Stock (NBER: National Bureau of Economic Research)H-Index: 75
#2Mark W. Watson (NBER: National Bureau of Economic Research)H-Index: 71
This article studies forecasting a macroeconomic time series variable using a large number of predictors. The predictors are summarized using a small number of indexes constructed by principal component analysis. An approximate dynamic factor model serves as the statistical framework for the estimation of the indexes and construction of the forecasts. The method is used to construct 6-, 12-, and 24-monthahead forecasts for eight monthly U.S. macroeconomic time series using 215 predictors in simu...
1,555 CitationsSource
where it denotes the Fed’s operating target for the federal funds rate, pt is the inflation rate (measured by the GDP deflator), yt is the log of real GDP, and y# t is the log of potential output (identified empirically with a linear trend). The rule has since been subject to considerable attention, both as an account of actual policy in the United States and elsewhere, and as a prescription for desirable policy. Taylor argues for the rule’s normative significance both on the basis of simulation...
556 CitationsSource
Cited By4
#1Stephen McKnight (El Colegio de México)H-Index: 2
#2Alexander Mihailov (University of Reading)H-Index: 9
Last. Fabio RumlerH-Index: 6
view all 3 authors...
Abstract Does theory aid inflation forecasting? To address this question, we develop a novel forecasting procedure based upon a New Keynesian Phillips Curve that incorporates time-varying trend inflation, to capture shifts in central bank preferences and monetary policy frameworks. We generate theory-implied predictions for both the trend and cyclical components of inflation, and recombine them to obtain an overall inflation forecast. Using quarterly data for the Euro Area and the United States ...
#1Giacomo Sbrana (NEOMA Business School)H-Index: 6
#2Andrea SilvestriniH-Index: 8
Last. Fabrizio VendittiH-Index: 10
view all 3 authors...
Forecasting inflation is an important and challenging task. This paper assumes that the core inflation components evolve as a multivariate local level process. While this model is theoretically attractive for modelling inflation dynamics, its usage thus far has been limited, owing to computational complications with the conventional multivariate maximum likelihood estimator, especially when the system is large. We propose the use of a method called “moments estimation through aggregation” (M.E.T...
7 CitationsSource
#1Yutaka (Aichi University)
Recently, much dispute has occurred about the validity of the New Keynesian model from both theoretical and empirical views. However, a few studies have analyzed this model from the empirical perspective. Few other studies have analyzed this model directly or nearly directly. This article empirically examines the New Keynesian model focusing on inflation forecast. Generalized method of moments (GMM) is used to examine whether the typical Keynesian model with Taylor rule is empirically appropriat...
We used the panel smooth transition regression (PSTR) model to investigate whether the relationship between inflation and macro variables remain consistent and identify the macro variables that dominate the fluctuations of inflation based on the uncertainty of interest rates and exchange rates for G7 over the period from 19841Q to 20114Q. The results of the empirical tests show that the real activity variables have superior explanatory power to CPI than unemployment rates based on the volatility...