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--Suggest Past Inflation Trend, Expectations May Be Better Predictors
--New Research Questions Helpfulness of Phillips Curve in Forecasting Inflation
By Karen Mracek
     WASHINGTON (MNI) - When looking for the best indicators of future
inflation, look to inflation expectations and even past inflation trends instead
of the employment gap, economists at the Federal Reserve Bank of Philadelphia
Federal Reserve Bank told MNI in an exclusive interview.
     The lack of inflation growth during the economic recovery has disappointed
and puzzled policymakers. This is because the Phillips curve model, which uses
the employment gap to predict inflation, "is not very helpful," Michael Dotsey,
director of research at the Philadelphia Federal Reserve Bank, said.
     Dotsey, along with Philadelphia Fed economists Shigeru Fujita and Tom
Stark, authored a paper that found "find no evidence for relying on the Phillips
curve during normal times, such as those currently facing the U.S. economy."
     Instead, "inflation itself, even just the simple naive forecast," may be a
better predictor of inflation, Stark said in an interview Wednesday. "Or how
fast the economy is growing. Growth-type of relationships are perhaps more
revealing."
     These days, "we are always very concerned about the way inflation
expectations feed into inflation," Stark said. "Inflation expectations are a
reasonable thing to look at ... to see whether (professional forecasters) are
anticipating" inflation.
     "One thing many, many people look at is what professional forecasters
think," he added, plugging the Philadelphia Fed's quarterly Survey of
Professional Forecasters.
     In the latest survey, economists marked down their forecast for core and
headline inflation measures. They now expected inflation to reach the Fed's 2%
target for core PCE in 2019, versus in 2018 in the previous quarter's survey.
     Measured on a fourth-quarter over fourth-quarter basis, the inflation
outlook released Aug. 11 was significantly lower for headline CPI inflation and
headline PCE inflation in 2017. Headline CPI was downgraded to an expected 1.7%
this year, versus 2.3% in the last survey. Headline PCE was down to 1.5%
forecast from 1.8% in the previous quarter. Meanwhile inflation for 2018 and
2019 was downgraded but only slightly.
     The policymaking Federal Open Market Committee also watches inflation
expectations to help forecast future inflation and in their most recent
statement said "survey-based measures of longer-term inflation expectations are
little changed, on balance."
     The Philadelphia Fed economists don't say for sure other non-employment
factors are better at predicting inflation -- their research focuses on the
Phillips curve. But they do say unemployment -- or rather the employment gap,
which measures how far the economy is from maximum employment -- "does not add
much value," Dotsey said.
     "The first baby step is to identify the problem," Stark explains. "What
this paper says is essentially, we don't see much benefit of using the Phillips
curve."
     Dotsey explained their research does not rule out that other labor measures
-- those that help economists to understand wage inflation, such as measures of
job movements -- could be helpful in forecasting inflation, just that "the
unemployment gap is not particularly helpful."
     The research finds the Phillips curve "may add value to the monetary policy
process during downturns, but the evidence is far from conclusive."
     Therefore the authors are not suggesting a complete abandonment of the
Phillips curve, which has been widely used since a paper by its namesake in
1958. Instead, they suggest policymakers look at many different models for
forecasting inflation. 
     One take away from their research, Stark said, "is if you put very high
forecast from Phillips curve, maybe want to take it down a notch."
--MNI Washington Bureau;tel: +1 202 371-2121; email: karen.mracek@marketnews.com

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