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International Finance Discussion Papers
The International Finance Discussion Papers logo links to the International Finance Discussion Papers home page A State-Dependent Model for Inflation Forecasting
Andrea Stella and James H. Stock
2012-1062  (November 2012)

Abstract:  We develop a parsimonious bivariate model of inflation and unemployment that allows for persistent variation in trend inflation and the NAIRU. The model, which consists of five unobserved components (including the trends) with stochastic volatility, implies a time-varying VAR 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 NAIRU has increased.

Full paper (253 KB PDF)

Keywords
Inflation forecasting, Phillips curve, trend-cycle model, NAIRU

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Last update: November 9, 2012