Evaluating the Efficacy of Supervised Machine Learning Models in Inflation Forecasting in Sri Lanka

Abstract

This study aims to forecast the inflation rate using supervised machine learning models (SMLM). While SMLMs are widely used in various fields, they have not been widely applied in forecasting inflation rates. Therefore, the main objective of this study is to identify the best model for forecasting inflation among four different SMLMs: LASSO regression (LR), Bayesian Ridge Regression (BRR), Support Vector Machine Regression (SVR), and Random Forest Regression (RFR) models. To achieve this objective, two different types of cross-validation techniques were employed: The k-fold cross-validation method (CVK) and walk forward validation (WFV) methods. These techniques were used to estimate the parameters and hyper-parameters for each machine learning model with root mean square error. The mean absolute percentage error (MAPE) was used to compare the performance of the different SMLMs. Empirical evidence from Sri Lanka between 1988 and 2021 was used to test the performance of the SMLMs in forecasting inflation rates. The results show that the SVR model with walk-forward validation is the best method for forecasting the future inflation rate of Sri Lanka based on the MAPE value. Overall, this study showcases the effectiveness of Supervised Machine Learning Models (SMLMs) in forecasting inflation rates, emphasizing the critical role of precise cross-validation techniques. These findings are invaluable for policymakers and investors, offering advanced tools for more informed economic decision-making and highlighting the potential of machine learning in enhancing macroeconomic stability and forecasting accuracy.