RDP 9002: Public Sector Growth and the Current Account in Australia: A Longer Run Perspective Appendix B: Expected Inflation

The calculation of real interest rates requires the estimation of a series for expected inflation. We use a simple forecasting model based on lagged values of the dependent variable and a vector of other variables thought to influence the formation of inflation expectations.

The models were estimated using quarterly data over the period 1961(3) to 1989(2) for both Australia and the US. The final forecasting equation (with insignificant variables dropped) for the expected change in the GDP deflator is:

where: Pe = expected change in the GDP deflator at time t for the period t+1
  p = actual change in the GDP deflator
  Y = Gross Domestic Product
  W = actual change in average weekly earnings,

Figures in parentheses are standard errors.

A similar equation was used to estimate the expected change in the Consumer Price Index (CPI). The final forecasting equation for the expected change in the CPI is:

The variables have the same meaning as in equation (131) except that the price terms refer to the CPI rather than to the GDP deflator.

The final forecasting equation for the expected change in the US GNP deflator is:

Again the variables have the same meaning as in equation (B1) except that the price terms refer to the US GNP deflator.