Can we rely on market-based inflation forecasts?

Abstract

A substantial decline in market-based measures of inflation expectations has raised concerns about low future inflation. An important question to address is whether these measures contain information that can improve upon alternative forecasting methods. This analysis finds that market-based inflation forecasts generally are no more accurate than surveys of professional forecasters or simple forecast rules. This suggests that financial markets can provide little additional useful forward-looking information about inflation. Correction: This Letter has been revised to incorporate into the analysis the indexation lag of inflation swap contracts. Figure 2 has been revised accordingly. An Addendum describes the changes in detail and includes additional results. The changes reflect a somewhat revised conclusion that market-based surveys cannot improve upon some of the most common methods for predicting inflation. The Federal Reserve’s dual mandate requires monetary policy to aim for both maximum employment and price stability. Although employment has recovered since the recession, inflation has consistently remained below the Fed’s 2 % longer-run objective. Because expectations of future inflation play an important role in determining current inflation, decreases in measures of inflation expectations based on market prices have raised some concerns. For example, between June 2014 and January 2015, one-year

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