DP11925 Deflating Inflation Expectations: The Implications of Inflation’s Simple Dynamics
This report examines the behavior of inflation in the United States since 1984 (updating Cecchetti et al. (2007)). Over this period, the change in inflation is negatively serially correlated, and the change in inflation is best predicted by a statistical model that includes only information from the two most recent quarters. We find that the level of inflation fluctuates around a slowly changing trend that we call the local mean of inflation. Few variables add extra explanatory power for inflation once the local mean is taken into account. This local mean is itself well characterized by a random walk. Labor market slack has a statistically significant, but quantitatively small, effect on the local mean and inflation expectations have no effect. Some financial conditions that are influenced by monetary policy have larger effects on the local mean. Concretely, this means that one-off moves in labor market slack or inflation expectations that are not mirrored in broader indicators of inflation pressures are unlikely to be predictive of changes in trend inflation.