Inflation: Do Expectations Trump the Gap?

FRB of St. Louis Working Paper No. 2006-013B

49 Pages Posted: 16 Apr 2006

See all articles by Jeremy Piger

Jeremy Piger

University of Oregon - Department of Economics

Robert Rasche

Michigan State University; National Bureau of Economic Research (NBER)

Date Written: July 2006

Abstract

We measure the relative contribution of the deviation of real activity from its equilibrium (the gap), "supply shock" variables, and long-horizon inflation expectations for explaining the U.S. inflation rate in the post-war period. For alternative specifications for the inflation driving process and measures of inflation and the gap we reach a similar conclusion: the contribution of changes in long-horizon inflation expectations dominates that for the gap and supply shock variables. Put another way, variation in long-horizon inflation expectations explains the bulk of the movement in realized inflation. We also use our preferred specification for the inflation driving process to compute a history of model-based forecasts of the inflation rate. For both short and long horizons these forecasts are close to those observed from surveys.

Keywords: Inflation persistence, Inflation forecast, Phillips Curve

JEL Classification: C32, E31

Suggested Citation

Piger, Jeremy M. and Rasche, Robert, Inflation: Do Expectations Trump the Gap? (July 2006). FRB of St. Louis Working Paper No. 2006-013B, Available at SSRN: https://ssrn.com/abstract=890659 or http://dx.doi.org/10.2139/ssrn.890659

Jeremy M. Piger (Contact Author)

University of Oregon - Department of Economics ( email )

Eugene, OR 97403
United States

Robert Rasche

Michigan State University ( email )

East Lansing, MI 48824
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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