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Estimating Trend Inflation Based on Unobserved Components Model: Is It Correlated with the Inflation Gap?
Author(s) -
HWU SHIHTANG,
KIM CHANGJIN
Publication year - 2019
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/jmcb.12600
Subject(s) - economics , econometrics , inflation (cosmology) , stock (firearms) , stochastic volatility , output gap , volatility (finance) , watson , random walk , indexation , monetary policy , keynesian economics , mathematics , statistics , computer science , mechanical engineering , physics , natural language processing , theoretical physics , engineering
Building on the work of Stock and Watson (2007), this paper empirically shows that a negative correlation between innovations to trend inflation and the inflation gap plays an important role in the dynamics of postwar U.S. inflation. Additional features that we incorporate in our model include regime‐switching inflation gap persistence and association between inflation and inflation uncertainty. The resulting estimate of trend inflation is smooth, and our model provides superior out‐of‐sample forecasts than Stock and Watson's (2007) unobserved components model with stochastic volatility or than Atkeson and Ohanian's (2001) random walk model does.