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Rising Expected Inflation … to about 2%

Summary:
The Survey of Professional Forecasters (SPF) February release and the January five year breakeven inflation rate suggest accelerating inflation – up to about 2.1%-2.2% Figure 1: Year on year expected inflation from University of Michigan survey median response (blue), from Survey of Professional Forecasters median response (red +), and implied five year average inflation from spread between five year constant maturity Treasurys and TIPS (green). NBER defined recession dates and peak in gray. Source: U.Michigan via FRED, SPF via Philadelpia Fed, and Treasury via FRED, NBER, and author’s calculations. The five year breakeven has risen further, to 2.37% as of yesterday (2/16). The latest observation for the Michigan survey of households (as opposed to economists) is for December, and comes

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The Survey of Professional Forecasters (SPF) February release and the January five year breakeven inflation rate suggest accelerating inflation – up to about 2.1%-2.2%

Rising Expected Inflation … to about 2%

Figure 1: Year on year expected inflation from University of Michigan survey median response (blue), from Survey of Professional Forecasters median response (red +), and implied five year average inflation from spread between five year constant maturity Treasurys and TIPS (green). NBER defined recession dates and peak in gray. Source: U.Michigan via FRED, SPF via Philadelpia Fed, and Treasury via FRED, NBER, and author’s calculations.

The five year breakeven has risen further, to 2.37% as of yesterday (2/16). The latest observation for the Michigan survey of households (as opposed to economists) is for December, and comes in at 2.5%. Interestingly, households have consistently higher expectations of year-ahead CPI inflation, relative to forecasters. See Coibion and Gorodnichenko (2015) for further discussion of the differences, and which one better fits the expectations augmented Phillips Curve; Detmeiter et al. (2016) examine how household inflation perceptions relate to inflation expectations.

Where will year-on-year inflation be in a year from now? Forecast errors for the Michigan and SPF (both based on medians) are shown below.

Rising Expected Inflation … to about 2%

Figure 2: Forecast error for year on year expected inflation from University of Michigan survey median response (blue), from Survey of Professional Forecasters median response (red +).NBER defined recession dates and peak in gray. Source: U.Michigan via FRED, SPF via Philadelphia Fed, NBER, and author’s calculations.

Over the sample period displayed in Figure 2, The average forecast error is -0.96 ppts for the Michigan survey (i.e., households overpredict inflation), while that for the SPF is -0.06 ppts. (The five year breakeven underpredicts on average 5 year inflation by 0.11 ppts for 2003-2015, although there is a lot of upward skew, so median error is overprediction.)

Menzie Chinn
He is Professor of Public Affairs and Economics at the University of Wisconsin, Madison

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