RDP 9207: Indicators of Inflationary Pressure 1. Introduction

The principal aim of monetary policy is the achievement of a low rate of price inflation. However, since monetary policy influences spending, and hence inflation, with lags that are always long and sometimes variable, policy makers must have sufficient warning of any incipient inflationary pressure if this objective is to be consistently achieved. This paper examines the statistical properties of a number of leading indicators of inflation, using Australian data over the period 1966 through 1991. We pay particular attention to the much-discussed P* (Hallman et al 1991, Hoeller and Poret 1991, Rasche 1991), as well as a measure of capacity utilisation, the cyclical rate of unemployment and the growth rate of a monetary aggregate (currency).

Our method for evaluating the usefulness of these indicators is to examine their out-of-sample forecasting performance, computing static real-time forecasts over the period 1984(1)–1990(2), and dynamic forecasts over the period 1990(3)–1991(4). Anticipating the conclusions, we find lags of inflation and various real variables, such as capacity utilisation, to be relatively good indicators of inflation. P*, on the other hand, does not perform well in this regard.

The remainder of the paper is organised as follows. In Section 2 we outline some indicative models of inflation. The data and their statistical properties are described in Section 3. In Sections 4 and 5 we report the estimation and forecasting properties of our models. Section 6 concludes.