The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Yasser Abdih, Ravi Balakrishnan, and Baoping Shang
INTERNATIONAL MONETARY FUND
Over the past two decades, U.S. core PCE goods and services inflation have evolved
differently. Against the backdrop of global concerns of low inflation, we use this trend as
motivation to develop a bottom-up model of U.S. inflation. We find that domestic forces play
a larger role relative to foreign factors in influencing core services inflation, while foreign
factors predominantly drive core goods price changes. When comparing forecasting
performance, we find that both the aggregate Phillips curve and the bottom up approach give
low root mean square errors. The latter, however, is more informative in tracing the effects of
shocks and understanding the exact channels through which they affect aggregate inflation.
Using scenario analysis-and given a relatively low sensitivity of core inflation to changes in
slack, both at the aggregate Phillips curve and sub-components levels-we find that global
pressures will likely keep core PCE inflation below 2 percent for the foreseeable future
unless the dollar starts to depreciate markedly and the unemployment rate goes well below
the natural rate. These results support the accommodative stance of monetary policy pursued
thus far and, going forward, underscore the need for proceeding cautiously and very
gradually in raising the federal funds rate.