U.S. inflation is forecast to increase slightly in 1999 and decrease
toward current levels in the year 2000. The New Classical School interpretation
of the Phillips Curve is the approach used in the forecast. U.S. monthly
inflation and unemployment rates from January 1993 through December 1998
were used to forecast inflation. The forecast implies stable inflation
and unemployment throughout 1999 and 2000. Average annual inflation of
2.22% is forecast for 1999, with 1.94% for 2000. (JEL: E130)
If the government and the Fed correctly identify the expected inflation rate, they can deliver a higherthanexpected rate of inflation in the shortrun. This in turn allows more workers to be hired to produce higherpriced goods. If the government and the Fed attempt to lower the unemployment level through inflationary policies, it is very important for the inflation forecast to be as accurate as possible.
The rest of this paper is organized as follows: Part 2. presents the
data used to forecast inflation rates; Part 3. presents the theoretical
basis for the approach adopted in forecasting inflation rates; Part 4.
presents forecasts of inflation rates for 1999 and 2000; Part 5. evaluates
the importance of the forecast for the economy; and Part 6. discusses conclusions
for economic policy.
The first variable is inflation. The rates are computed from the Consumer Price Index: Total; All Urban Consumers. This data was taken from the Federal Reserve Bank of St. Louis Federal Reserve Economic Data (FRED). The FRED descriptor is CPIAUCSL. The inflation rate was computed as the annualized percent change in the CPI. The rates used for the sample period were seasonally adjusted annual rates for each month from 1993 to 1998. The second variable was unemployment. The FRED descriptor for the unemployment rate is UNRATE. The rates taken for the sample period were from every month from years 1993 to 1998. The forecast horizon is two years into the future. This data was used because it is readily available over the Internet and practically anyone who wants this information can easily find it there. Inflation and unemployment are essential parts of the Phillips Curve so they had to be used to complete the forecast.
The Phillips Curve and variables were used because of the relationship that exists between them. Data was found on unemployment and inflation that ultimately led the project to its conclusion. The data found stated ".. we can only reduce inflation, for any given rate of increase productivity, at the cost of higher unemployment". (Mueller 1966, p. 439.) This puts into words the shortrun Phillips Curve relationship between unemployment and inflation. Unemployment is a function of inflation in the Phillips Curve:
Where i = inflation and u = unemployment. The regression model used is the basic univariate model. Solving for inflation, the forecast target, the equation is written as:
The constants a and b are computed in the regression and are given as the intercept coefficient (a) and X variable coefficient (b). Lagging the righthandside of the Phillips Curve by twentyfour months yields the following forecasting equation:
This equation is estimated in Part 4 and is used to calculate the inflation forecast.
Unemployment was lagged twentyfour months to forecast inflation. The Rsquare is 0.46997 and the adjusted Rsquare is 0.4608, indicating approximately 46% of the variation in inflation is explained by variation in unemployment from two years earlier. The regression estimate is (with tstatistics in parentheses):
This equation will give the expected inflation rates when unemployment rates from the past two years are put in. The following equation is for the forecast inflation rate for December 1999 and the X variable is unemployment from the month of December in 1997:
This equation is shown as an example of how the inflation forecast was
computed for each month in 1999 and 2000. Forecast inflation rates are
given in Table 1.







January


January



February


February



March


March



April


April



May


May



June


June



July


July



August


August



September


September



October


October



November


November



December


December


The results of the forecast are quite believable. It would not be surprising
for inflation and unemployment to remain very low for the next two years.
The unemployment rate now is at 4.3% for 1998. Since the unemployment rate
and inflation rate are inversely related in the short run, the forecast
implies unemployment rates will be about the same, with a possibility of
unemployment being even lower throughout 1999. Then unemployment will rise
back to almost the exact percent it is now by December 2000, as inflation
rises back to current levels. Employer difficulty in filling job vacancies
should moderate at that time. Low forecast inflation suggests anyone thinking
of buying any large purchase such as a home or car should do so within
the next couple of years while inflation rates are still low.
Federal Reserve Bank of St. Louis, Federal Reserve Economic Data (FRED), http://www.stls.frb.org/fred/.
Mueller, M.G., ed., Readings in Macroeconomics, New York: Holt, Rhinehart, & Winston, 1966.
Thomas, Lloyd B., Money, Banking, and Financial Markets, New York: McGrawHill, 1997.