More on switching the inflation system

Is core inflation the CPI in a new system? Results using the Markov permutation model (innovated by James Hamilton).

Figure 1: Core CPI inflation m/m in logarithms (blue). The National Bureau of Economic Research has peak-to-trough recession dates highlighted in grey. Source: BLS, NBER, and author accounts.

Applying a simple two-order Markov permutation estimation method (implemented in EViews, using default settings, allowing for different variances) over the period 1960–2022 yields the following estimate.

This estimate results in the following estimates for the systems (refined, homogenous):

It is estimated that there is a 30% chance of being in a low inflation regime. The results are somewhat sensitive to assumptions about the variances in the two systems. Imposing covariance constraints leads to the following estimated probabilities of coexistence in the two systems.

By constraining co-variances, the indications are much stronger for a shift to a low-inflationary regime.

This entry was posted on by Minzy Chen.

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