How can we improve inflation forecasts
Just imagine you ordered a cheeseburger. Then low and behold, a salad is brought to your table. The probability of such a thing happening is not zero, especially in a busy restaurant, mix ups happen. It's happened to all of us. Spare a thought for central banks over the past few years, who repeatedly got served salad, when looking at how their inflation forecasts panned out. There have been articles in the press which have tried to dissect precisely what wrong for central bank forecasts recently (see Central banks rethink forecasting after failures on inflation - FT 27 Dec 2023?and Ben Bernanke to lead Bank of England review into forecasting - FT 28 Jul 2023). In this article, I'll try to summarize some of the points these articles make, whilst later adding some of my own suggestions on how inflation forecasting can be improved.
Shocking stuff when it comes to inflation
Notably, the main part of the issue with central banks inflation forecasts was not seeing how a plethora of shocks, whether it was COVID to the Ukraine invasion could push up inflation as significantly as it did. Then there is the whole team transitory debate about whether inflation's rise was purely a result of these shocks, or would be more long lasting (see Why team transitory is still wrong - FT 27 Dec 2023). Then there's been folks like Larry Summers, who suggested that an extended period of high unemployment was necessary for inflation to fade (see Larry Summers Says US Needs 5% Jobless Rate for Five Years to Ease Inflation - Bloomberg 22 Jun 2022). Admittedly, the former Treasury Secretary is not a central banker, but his view has not been unique. On the other side of the argument, have been economists such as Claudia Sahm who have argued against using the Phillips curve ie. the trade off between inflation and unemployment (see Claudia Sahm: it's clear now who was right - FT 07 Dec 2023). Sahm suggested that inflation could come down without a large increase in unemployment, a view which does seem to have materialised.
领英推荐
We must first acknowledge that the shocks were not predictable....
Co-founder at Turnleaf Analytics / Macro forecasting with ML
1 年The burger in the photo was also very tasty ??
Co-founder at Turnleaf Analytics / Macro forecasting with ML
1 年For a much more detailed discussion of the difficulties with central bank forecasts and the whole "team transitory" debate, I'd recommend these articles, which I've referenced https://www.ft.com/content/5d7851f3-ef7c-4599-8a5c-c34cecb83511 and https://www.ft.com/content/e68ce6a9-bc4c-4cb0-ac24-75a319dfdca9
Founder and chairman of the board of L3C , member of the board of Turnleaf Analytics serial entrepreneur and Angel investor
1 年Yes a lot of the focus of central banks seems to be on looking at more scenarios rather than using Aletrnative data and ML to improve the methodology of forecasting
Hi Saeed! Fascinating piece. Love it. I think you're suggesting "augmenting traditional models with alternative data" rather than a switch of model methodologies. You poke on the OLS/ML discussion, but in your opinion, will the DSGE model stack survive?