FOR CLOSE to 40 years, the US and much of the world were blessed with low inflation. No longer. Depending on whom you believe, the dramatic price and wage spike of the last few months is either a flash in the pan or the beginning of something more ominous. Both sides in this debate speak withabout what will happen next. But the history of inflation forecasting suggests that humility is in order.
In time, economists developed different versions of the Phillips Curve model. Most revolved around an ideal baseline rate of unemployment. Go above this sweet spot, and inflation would fall; go below it, and inflation would rise. This rate was dubbed the Non-Accelerating Inflation Rate of Unemployment, shortened to the unlovely acronym Nairu.
“We establish this naive forecast as our benchmark,” they explained, “not because we think that it is the best forecast of inflation available, but rather because we think that any inflation forecasting model based on some hypothesized economic relationship cannot be considered a useful guide for policy if its forecasts are no more accurate than such a simple atheoretical forecast.”
But it’s worth recalling that these temporary improvements in forecasting power were relative to a “model” that a child could have invented. by the economists Marie Diron and Benoit Mojon, who came up with their own, equally interesting thought experiment. Their comparative “model” was even simpler: take a central bank’s inflation target and then use that number as a consistent prediction for inflation every single year.
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