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Don’t bother trying to predict inflation: You can’t

Jerome Powell
AP/Jacquelyn Martin
Federal Reserve Chair Jerome Powell speaks at a news conference Wednesday, Sept. 21, 2022, at the Federal Reserve Board Building, in Washington. Intensifying its fight against chronically high inflation, the Federal Reserve raised its key interest rate by a substantial three-quarters of a point for a third straight time, an aggressive pace that is heightening the risk of an eventual recession. (AP Photo/Jacquelyn Martin)

Economists, policymakers, economic analysts and the general public are all trying to figure out where inflation is headed. So far, their attempts have failed. Some predicted that inflation would decline if the price of gas declined.

The price of gas did decline, but inflation didn’t. Others predicted that headline inflation would slow if core inflation declined. Well, core inflation did decline. Headline inflation didn’t. Others, who blamed inflation on supply chain problems, suggested that inflation would abate as the supply chain issues abated. They have. Inflation hasn’t.

One reason inflation is unpredictable is that many of the prices that affect the inflation rate themselves are unpredictable. These prices include the prices of commodities such as oil, natural gas and corn. When these prices rise, they raise the production costs of a wide variety of other goods and services.

Commodity prices and a host of other prices are unpredictable because the future cannot be predicted. Yesterday’s prices for these commodities reflect all the information market participants knew yesterday, including market participants’ expectations of future events. Tomorrow’s price will reflect all the new information (news) the market will receive tomorrow, including changes in market participants’ expectations of future events. The next-day’s prices will reflect all the news received the next day, and so on.

To predict tomorrow’s price today, you would have to be able to predict the news the market will receive tomorrow. Moreover, you will have to be able to predict the direction and the amount that the price of oil, corn, etc. will respond to that news. To predict the price a month or year from today, you would have to be able to predict the news that would be received over the next month or year. Moreover, you would have to be able to correctly anticipate how the price of the commodity would respond to all the new information received during the period.

No one can do that, not even your psychic or your uncle Joe. (He just thinks he can.)

Similarly, today’s price of Sony TVs or other consumer goods is determined by the supply of and demand for those goods today. Tomorrow’s price will be determined by the supply of and demand for those goods tomorrow. While it is a good bet that tomorrow’s price will be the same as today’s price, it is much less certain what the price will be a month or a year from now because the future is unpredictable. Moreover, the price will be much less predictable when the prices of other goods and services are increasing.

The unpredictability of inflation is further complicated by the fact that inflation is a complicated and poorly understood dynamic process that depends on many factors. The recent inflation has been attributed to the Ukraine war, supply-chain problems, an overly generous Cares Act, other government spending, the Federal Reserve’s aggressively easy monetary policy, labor shortages, wage growth and inflation expectations. The path of inflation will be determined by a confluence of the paths of these unpredictable factors (and perhaps others). Furthermore, it is impossible to know the degree to which each will contribute to future inflation or for how long each impact will last.

Complicating all of this is the breadth of the inflation we are seeing around the world. It is impossible to know whether and to what extent inflation in the United States is affected by factors outside the U.S.

For all these reasons, it is impossible to predict the inflation rate going forward. Oh, you might get lucky once in a while and predict inflation reasonably accurately, but you will never be able to do it consistently. 

Daniel L. Thornton retired from the Federal Reserve Bank of St. Louis in 2014. He is currently president of D.L. Thornton Economics LLC.

Tags Federal Reserve inflation inflation fears Inflation Reduction Act supply chain issues

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