A New Model of Inflation, Trend Inflation, and Long‐Run Inflation Expectations

Abstract

This paper develops a bivariate model of inflation and a survey‐based long‐run forecast of inflation that allows for the estimation of the link between trend inflation and the long‐run forecast. Thus, our model allows for the possibilities that long‐run forecasts taken from surveys can be equated with trend inflation, that the two are completely unrelated, or anything in between. Using a variety of inflation measures and survey‐based forecasts for several countries, we find that long‐run forecasts can provide substantial help in refining estimates and fitting and forecasting inflation. It is less helpful to simply equate trend inflation with the long‐run forecasts.

Trend Inflation and Inflation Compensation

“…6 Calculated as the probability mass associated to in ‡ation higher than 2% over the probability mass associated to in ‡ation lower than 1.5%. 7 The rebound of in ‡ation risk premia into positive territory since late 2016 is also consistent with the sharp improvement in those two dimensions of the long-term forward RND reported in Gimeno and Ibañez (2016).…”

“…This conditional density is non-standard, which means a Metropolis-Hasting step must be undertaken to draw d;i . We follow Chan et al (2017) where they implement an independence chain Metropolis-Hasting step with a proposal distribution N (^ d; To draw , we follow Chan (2013) by implementing an independence chain Metropolis-Hasting step. Speci…cally, we evaluate the log-density below using band matrix routines, where we maximize it numerically to obtain the mode and negative Hessian, denoted as^ and K .…”

“…; 2 b ; IG( g ; S g ); g = 2 d004 Chan et al (2017). notes that these prior choices are relatively noninformative and they also found that these priors are fairly robust in terms of a prior sensitive analysis.Gibbs SamplerTo simulate the posterior distributions, we follow Chan et al(2018) and implement a nine block Gibbs Sampler that sequentially draws from each conditional posterior distribution.…”

Macroeconomic Changes with Declining Trend Inflation: Complementarity with the Superstar Firm Hypothesis

“…5 As for the forces driving some of the US macroeconomic changes, the literature has pointed to globalization and technological changes (Autor et al (2020)), weakened antitrust enforcement (Gutiérrez and Philippon (2017b)), and patent concentration (Akcigit Notes: The figure displays key US macroeconomic time series from 1980 to 2019 or for available years. In panel (a), the solid (blue) line illustrates the average price-cost markup, which is a cost-weighted counterpart of the sales-weighted average markup of De Loecker et al (2020), while the dashed (red) line displays the trend inflation rate of the personal consumption expenditures (PCE) price index estimated by Chan et al (2018). Panel (b) shows corporate profits adjusted for inventory valuation and capital consumption as a share of value added of the nonfinancial corporate sector.…”

“…Panel (d) presents the share of business fixed investment in spending, where spending is measured as the sum of business fixed investment, PCE for nondurable goods, and PCE for services. Sources: Chan et al (2018), De Loecker et al (2020), US Bureau of Labor Statistics, US Bureau of Economic Analysis, Haver Analytics.…”