Why Has U.S. Inflation Become Harder to Forecast?

James H. Stock, Mark W. Watson

NBER Working Paper No. 12324
Issued in June 2006
NBER Program(s):   EFG   ME

Forecasts of the rate of price inflation play a central role in the formulation of monetary policy, and forecasting inflation is a key job for economists at the Federal Reserve Board. This paper examines whether this job has become harder and, to the extent that it has, what changes in the inflation process have made it so. The main finding is that the univariate inflation process is well described by an unobserved component trend-cycle model with stochastic volatility or, equivalently, an integrated moving average process with time-varying parameters; this model explains a variety of recent univariate inflation forecasting puzzles. It appears currently to be difficult for multivariate forecasts to improve on forecasts made using this time-varying univariate model.

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Published: Stock, James H. and Mark W. Watson. "Why Has U.S. Inflation Become Harder to Forecast?" Journal of Money, Credit and Banking 39, s1 (2007): 13 - 33.

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