A state-dependent model for inflation forecasting

Abstract

AbstractA parsimonious bivariate model of inflation and unemployment is developed that allows for persistent variation in trend inflation and in the non-accelerating inflation rate of unemployment. The model, which consists of five unobserved components (including the trends) with stochastic volatility, implies a time-varying vector autoregression model for changes in the rates of inflation and unemployment. The implied backwards-looking Phillips curve has a time-varying slope that is steeper in the 1970s than in the 1990s. Pseudo out-of-sample forecasting experiments indicate improvements upon univariate benchmarks. Since 2008, the implied Phillips curve has become steeper and the non-accelerating inflation rate of unemployment has increased.