Don’t Forget Future Inflation When Making Financial Decisions by Jia Liu, PhD – AIER
People predict future inflation in many decisions they make, from taking out a car loan or a mortgage, to deciding whether to put money in CDs, bonds, or stocks. Future inflation is also important for the expected profitability of business investment projects.
Inflation for the price of a new home, for instance, was about 4.3 percent in 2015. If we estimate that this trend will continue, a home buyer would rather buy a house now than later.
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Inflation is also critical to consumption and production. Sluggish price growth (or deflation) would be welcomed by buyers, but would hurt producers’ revenues and then put constraints on wage growth. But a high inflation that gets out of control would discourage consumption and investment by reducing the purchasing power of incomes and savings.
Given the importance of inflation for economic conditions, both individuals as economic players and policy makers pay close attention to price changes. The U.S. central bank, for example, is tasked with maintaining price stability as one of the goals in its dual mandate—maximum employment and price stability.
But throughout U.S. history, undesirable high and low inflation both existed, and both have proved to be costly to the economy. The stagflation crisis in the late 1970s caused a stock market crash and very high unemployment in the early 1980s. On the other hand, the sluggish price growth in recent years has raised much concern. Some argued low inflation may have contributed to soft business investment and slow wage growth.
So it is helpful to be able to predict inflation. But despite the enormous attention to inflation, inflation forecasting has been lacking good tools and models. The American Institute for Economic Research has developed a new model that improves on the performance of existing models. Our model is based on advanced time series analysis techniques, which take into account various economic variables to capture the trend of inflation changes. More than half a century of data were used to estimate the model and the resulting forecast. The inflation forecasts created with the model have tested well over the last three decades and outperform the existing comparable models.
This model can be used to get a glimpse of the all-important future inflation. For the next six months, the model predicts that the average inflation in the core CPI (the consumer price measure that excludes volatile components of food and energy) will be in the range of 0.14 to 0.17 percent per month, or an annualized 1.7 to 2.1 percent. This is similar to the inflation we have seen in the past five years.
This mild inflation forecast for the coming months confirms what AIER’s Inflationary Pressure Scorecard shows (see the upcoming AIER’s June Business Conditions Monthly). While recent consumer prices posted positive growth, the scorecard shows an easing inflationary pressure for the months ahead.