The US inflation mystery of 2017

WASHINGTON • A year ago, Bloomberg asked economists to predict how 2017 would unfurl. With the year almost over, we've compared the forecasts to actual performance and, well, the results weren't pretty.

This was the year that the textbook connection between inflation and unemployment broke down, bedeviling forecasters. So much so that our survey respondents pulled off a rare feat: missing to the upside their forecasts for both inflation and the jobless rate. Typically a miss in one direction for one of those measures accompanies a miss in the opposite direction for the other. Not so in 2017.

"We can definitely learn from that," said Mr Christopher Low, chief economist at FTN Financial in New York, who was among the best predictors of inflation (and among the worst on unemployment). "The thing we're looking at here now is trying to understand where the inflation-unemployment relationship broke down."

Only one forecast, submitted by Mr Francois Dupuis and Mr Francis Genereux at Desjardins Group, managed to come within 0.3 percentage point of the actual results on both unemployment and inflation. Bravo.

How this year's results force economists to change the way they forecast 2018 depends crucially on whether they believe the mystery of low inflation will continue. More seem to be moving into the camp that says low inflation can't be completely explained by transitory factors. 

"I don't think it's a one-year phenomenon," said Mr Stephen Gallagher, chief US economist at Societe General in New York. "It's something of a new paradigm."

By November last year, unemployment was at 4.6 per cent, about where many economists thought was its lowest sustainable rate. Few believed US employers would add about 2 million jobs this year, pushing joblessness to 4.1 per cent.

If economists missed unemployment to the high side, you'd think they would miss inflation to the low side, right? Wrong. That's the "mystery" of 2017, as described by Federal Reserve chair Janet Yellen. That caught about everyone by surprise as inflation stayed disturbingly low at 1.5 per cent in the 12 months to November against surprisingly strong job gains.

"One of the biggest forecasting hurdles for 2017 was understanding the nature of the inflation soft-patch; many economists misread the signals and expected it to subside quickly, when in reality it was a reflection of weak economic performance from four to six quarters earlier," said Mr Carl Riccadonna of Bloomberg Economics.

In a forecast linked to inflation, economists showed a similar miss when predicting the yield on 30-year Treasuries. The median estimate was for 3.34 per cent at the end of 2017. It was 2.75 per cent late on Wednesday afternoon.


A version of this article appeared in the print edition of The Straits Times on December 29, 2017, with the headline 'The US inflation mystery of 2017'. Print Edition | Subscribe