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Why a short-term view of inflation should take precedence

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Jan. 22 2015, Updated 12:25 p.m. ET

Survey based Estimates: Short-term view of inflation is more crucial than long-term 

The Fed turns to survey-based estimates for inflation developments, but they have their flaws. Although these estimates include forecasts drawn from macroeconomic models, their results tend to undershoot or remain fairly flat for considerable periods of time. The stability from these surveys can be misleading and encourage policy inaction. Case in point: The Survey of Professional Forecasters, a well-respected report produced by the Philadelphia Fed regional bank, sees inflation expectations remaining well anchored at 2% for the long run, but the forecast has maintained that level through the global financial crisis, which is not an accurate representation. Indeed, over the long run, inflation may reach 2%, but in the interim, since economic activity is always a function of present economic conditions, attention should be on short-term view of inflation.

short-term view of inflation forecast

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Market Realist – Now that we know that the short-term view of inflation is more important than a long-term view, let’s understand what the short-term view says. According to the Survey of Professional Forecasters, the recent forecasts for both CPI (Consumer Price Index) and PCE (personal consumption expenditures) inflation for the next three years are lower than previous survey estimates. The current estimates are discussed in the previous graph. The Fed uses the PCE inflation as an indicator to judge inflation and focuses more on the core than the headline measure. The core measure excludes food and energy (XLE) prices, which are considered volatile in nature.

Forecasts expect the headline CPI inflation to average 1.9% in 2015 and 2.1% in 2016, down from the 2.2% and 2.3% estimated in the survey conducted three months prior. The PCE inflation is expected to average 1.8% in 2015 and 1.9% in 2016, down from the previous survey’s estimates of 2%.

Low inflation is likely to affect bond yields (TLT) (IEF) and keep gold (GLD) (IAU) prices low.

Markets are less optimistic in terms of their inflation expectations. Read more about this in the next part of the series.

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