What is Keeping U.S. Core Inflation Low : Insights from a Bottom-Up Approach

Author/Editor:

Yasser Abdih ; Ravi Balakrishnan ; Baoping Shang

Publication Date:

July 5, 2016

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

Over the past two decades, U.S. core PCE goods and services inflation have evolved differently. Against the backdrop of global concerns of low inflation, we use this trend as motivation to develop a bottom-up model of U.S. inflation. We find that domestic forces play a larger role relative to foreign factors in influencing core services inflation, while foreign factors predominantly drive core goods price changes. When comparing forecasting performance, we find that both the aggregate Phillips curve and the bottom up approach give low root mean square errors. The latter, however, is more informative in tracing the effects of shocks and understanding the exact channels through which they affect aggregate inflation. Using scenario analysis—and given a relatively low sensitivity of core inflation to changes in slack, both at the aggregate Phillips curve and sub-components levels—we find that global pressures will likely keep core PCE inflation below 2 percent for the foreseeable future unless the dollar starts to depreciate markedly and the unemployment rate goes well below the natural rate. These results support the accommodative stance of monetary policy pursued thus far and, going forward, underscore the need for proceeding cautiously and very gradually in raising the federal funds rate.

Series:

Working Paper No. 16/124

Subject:

English

Publication Date:

July 5, 2016

ISBN/ISSN:

9781498347297/1018-5941

Stock No:

WPIEA2016124

Price:

$18.00 (Academic Rate:$18.00)

Format:

Paper

Pages:

38

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