Alternative Indicators for Predicting the Probability of Declining Inflation

Abstract

Performance of inflation indicators for predicting the probability of inflation falling inside constant and moving targets is considered with a probit model using U.S. data. Given Fed emphasis on achieving price stability, particular attention is given to the target that future inflation will be below recent inflation. In contrast with earlier years, the unemployment and capacity utilization rates do not perform well at forecasting the direction of inflation in the mid and late 1990s. We suggest that extending Keynesian Phillips curve analysis to consider changes in labor market conditions, technological advance and worker skills, and openness will increase understanding of these issues.

Keywords: Probit model, out-of-sample forecast, inflation targets, inflation indicators

JEL Classification: C25, E31, E37, G18