Grace Potter and the Nocturnals: Low Road
For the Virtual Green Room: June 3, 2011

Markets Don't Expect Inflation; Professional Forecasters Don't Expect Inflation; and Economists Who Know How to Do Their Job Don't Expect Inflation

Only those carrying water for the Republican Party, and policymakers and economists in Europe who don't seem to understand how to forecast fear inflation.

Paul Krugman:

Core Madness: Mike Bryan... has just posted some very useful analytics on core versus headline inflation. His question is, which backward-looking inflation measure should you look at if you want to predict headline inflation over the medium term, defined as the next 36 months.... [I]f you want to predict inflation over the next three years, you really don’t want to look just at inflation over the past 3 months or 6 months; you really want to look at inflation over the past three years. And if for whatever reason you want to use a shorter historical period — say, because you think there may have been some big policy shifts — you should use core inflation, not headline.... [I]f you want to use headline inflation as a forecast, you want to use a fairly long lag, such as headline inflation over the past 3 years. And headline inflation over the past three years has been low.

The point is that there’s a kind of bait-and-switch on the part of inflationistas. They point to results suggesting that you can use headline inflation to make medium-term forecasts about as well as using core inflation — results that depend on not using high-frequency inflation data, but instead using multi-year averages. And then they demand tight-money policies on the basis of short-term inflation measures, when the longer-term measures that “work” statistically aren’t going anywhere.

Do this right, and whichever inflation measure you prefer, there’s no reason to tighten.