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Core Inflation Revisited: Forecast Accuracy across Horizons
FRB of St. Louis
2024.03.04
Throughout 2023, inflation forecasting was the focus of our On the Economy blog posts. Our main interest lay in the predictive content of individual components of inflation for aggregate inflation. That is, we asked: Out of the goods or services in the proverbial basket today, whose price increases will be most useful in predicting the price increase of the whole basket, h months into the future? Answering this question helps clarify the motivation behind core measures, which either excludes only energy inflation (core excluding energy), or both energy and food inflation (core), due to the volatility in food and energy prices.
In this essay, we shift our perspective away from comparisons between core and its components. Instead, we focus on core and its “content horizon.” This concept, discussed in Jorg Breitung and Malte Kn?ppel’s 2021 article, asks how far into the future a particular forecast remains informative beyond just using the historical average. Based on a collection of forecasts from professional forecasters and a range of countries, they found that the content horizons were two to three quarters in the future for annualized quarterly GDP growth and three to four quarters in the future for year-over-year inflation. Beyond that you might as well just use the historical average.