Working Paper: CEPR ID: DP7183
Authors: Janine Aron; John Muellbauer
Abstract: Inflation targeting central banks will be hampered without good models to assist them to be forward-looking. Many current inflation models fail to forecast turning points adequately, because they miss key underlying long-run influences. The world is on the cusp of a dramatic turning point in inflation. If inflation falls rapidly, such models can underestimate the speed at which interest rates should fall, damaging growth. Our forecasting models for the new measure of producer price inflation suggest methodological lessons, and build in conflicting pressures on SA inflation from exchange rate depreciation, terms of trade shocks, collapsing oil, food and other commodity prices, and other shocks. Our US and SA forecasting models for consumer price inflation underline the methodological points, and suggest the usefulness of thinking about sectoral trends. Finally, we apply the sectoral approach to understanding the monetary policy implications of introducing a new CPI measure in SA that uses imputed rents rather than interest rates to capture housing costs.
Keywords: forecasting inflation; homeowner costs in the CPI; PPI inflation; South Africa
JEL Codes: C22; C51; C52; C53; E31; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inflation forecasting models that include long-run relationships (F37) | better at predicting turning points in inflation (E31) |
| increased trade openness (F19) | significant reduction in inflation in South Africa (E31) |
| increased trade openness (F19) | changes in import prices (F14) |
| increased trade openness (F19) | changes in labor costs (J39) |
| unit labor costs (J39) | substantial long-run impact on consumer prices (E31) |
| unit labor costs (J39) | central role in inflation dynamics (E31) |
| new CPI measure that includes imputed rents (C43) | significant implications for inflation measurement and monetary policy in South Africa (E31) |