Forecasting Inflation Using the Phillips Curve: Evidence from Swedish Data

Abstract

This paper studies the forecasting ability of various Phillips curve specifications in a pseudo out-of-sample exercise for Swedish inflation over the period 1980–2014. Three measures of inflation are considered––headline inflation, underlying inflation, GDP deflator inflation, in addition to different activity variables, various econometric specifications and different sample periods. Although the results indicate heterogeneity in individual model performance and evidence of model instability, in general, the Phillips curve models improve inflation forecasts against the random walk benchmark for both headline inflation and underlying inflation, and fail to beat the random walk benchmark for GDP deflator inflation. Phillips curve forecasts beat the random walk benchmark especially for 2004–2013. The monetary regime change in 1993 from exchange rate targeting to inflation targeting is also taken into account. The results suggest that for all Phillips curve models and all three inflation measures, the performance of the Phillips curve depends on whether the data used for making the predictions was under the inflation targeting regime or not. Univariate forecasting models perform well for the fixed exchange rate regime period, but the Phillips curve models are useful under the inflation targeting regime.