Why Did US Inflation Forecasts Fail?

Major central banks, including the Federal Reserve (Fed) made a sequence of expensive forecast errors on inflation. It is essential to understand why these errors arose and learn lessons about how to forecast inflation better, which will benefit policy formulation. In this box, I investigate why these errors may have arisen.

In particular, I use two approaches to construct forecasts for inflation over this period: modelling inflation via a simple autoregressive (AR) process and modelling inflation as a single equation. I show that it is important not to include constants in empirical models of inflation as doing so implies a belief that inflation will return to its average rate of its own accord.