Inflation and Professional Forecast Dynamics: An Evaluation of Stickiness, Persistence, and Volatility * Elmar Mertens † and James M. Nason ‡ Current draft: May 15, 2019 First Draft: February 15, 2015 Abstract This paper studies the joint dynamics of U.S. inflation and a term structure of aver- age inflation predictions taken from the Survey of Professional Forecasters (SPF). We combine an unobserved components (UC) model of inflation and a sticky information forecast mechanism to study these dynamics. The UC model decomposes inflation into trend and gap inflation, builds persistence into the inflation gap, and imposes stochas- tic volatility on the innovations to trend and gap inflation. We innovate by endowing inflation gap persistence in the UC model and the frequency of sticky information infla- tion forecast updating with drift. The result is a non-linear state space model. The state space model is estimated on a sample from 1968Q 4 to 2018Q 3 using sequential Monte Carlo methods that include a particle learning filter and a Rao-Blackwellized particle smoother. Our estimates show that (i ) longer horizon average SPF inflation predictions inform estimates of trend inflation; (ii ) inflation gap persistence is procyclical before the Volcker disinflation and acyclical afterwards; (iii ) by 1990 sticky information inflation forecast updating is less frequent than it was earlier in the sample; and (iv ) the drop in the frequency of the sticky information forecast updating occurs at the same time persistent shocks become less important for explaining fluctuations in inflation. JEL Classification Numbers : E31, C 11, C 32. Key Words : inflation; sticky information; professional forecasts; unobserved compo- nents; stochastic volatility; time-varying parameters; Bayesian; particle filter. † email : [email protected], address : Deutsche Bundesbank, Central Office– Research Centre, Wilhelm-Epstein-Straße 14, 60431 Frankfurt am Main, Germany. ‡ email : [email protected], address : Department of Economics, Campus Box 8110, NC State University, Raleigh, NC 27695 and Centre for Applied Macroeconomic Analysis. * We thank Gregor Smith for several conversations that motivated this paper. We also received valuable comments from Frank Schorfheide (the co-editor), three anonymous referees, Todd Clark, Patrick Conway, Drew Creal, Bill Dupor, Andrew Filardo, Monica Jain, Alejandro Jus- tiniano, and Wolfgang Lemke and suggestions from colleagues and participants at numerous seminars and conferences. Jim Nason thanks the Jenkins Family Economics Fund at North Carolina State University for financial support. The views herein are those of the authors and do not represent the views of the Deutsche Bundesbank or the Eurosystem. Supplementary material and results can be found in an online appendix available at www.elmarmertens.com.
