Blog - Investing Notes

August 20, 2008 - Status of the Inflation Forecast Flyoff

The inflation rate forecast flyoff now incorporates 40 months of live testing for three granular (month-by-month or quarter-by-quarter) 12-month trailing consumer inflation rate forecasts, all freely available on the web: (1) the BMO Nesbitt Burns United States Economic Outlook; (2) our own simple extrapolation (CXO); and, (3) the Financial Trend Forecaster (FTF) Moore Inflation Predictor. The flyoff is for one-month-ahead accuracy only. Which model is winning? Using accumulated forecast and actual inflation data for 4/05-7/08, we find that:

The following chart tracks the three one-month-ahead inflation forecasts and actual inflation over the entire sample period. Visual inspection reveals no obvious winner.

For greater precision, we compare monthly changes in data.

The following table compares statistics for the monthly differences between forecast and actual data for all three forecasts, and for a dumb benchmark forecast that assumes this month's inflation rate is the same as last month's actual inflation rate ("Same as Last Month"). Results indicate that:

• The BMO, CXO and dumb benchmark one-month-ahead forecasts are on average a little too low over the sample period. The FTF forecast is on average a little too high.
• All three one-month-ahead forecasts track the actual inflation rate more closely than the dumb benchmark. The CXO and FTF forecasts track actual inflation more closely than the BMO forecast.

Note that the above monthly testing method does not quite fit the BMO quarterly forecast approach.

Untested observations for forecast horizons beyond one month are that the BMO forecast tends to change most slowly in reaction to new actual monthly inflation rate data, while the FTF forecast tends to be quite volatile from month to month.

In summary, limited evidence suggests that freely available near-term inflation rate forecasts are about equally accurate (or inaccurate) for the next month.

For additional background, see Inflation Forecast. See also our blog entry of 7/10/06 for more detail on the CXO inflation forecast error analysis.