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An Ordered Probit Approach to Predicting the Probability of Inflation/Deflation

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  • John Silvia
  • Azhar Iqbal

Abstract

This paper provides an ordered probit approach that estimates the probability six months in the future of three distinct scenarios for prices: inflation, deflation, or price stability. The traditional way of forecasting inflation is to predict a single level and/or growth rate of the PCE deflator. However, this approach is not useful for identifying options or risks facing decision-makers, especially in financial markets. Also, point estimates of inflation convey a sense of overconfidence. Our approach is more practical for decision-makers who must hedge their portfolios, but it is also useful for policymakers, investors, and consumers who must attach a probability with each possible scenario of future price trends. Our results indicate that since June 2011 the probability of deflation has been persistently higher than of the other two scenarios. Thus, the recent years’ higher deflation probabilities may offer a justification for the persistence of the Federal Reserve’s highly accommodative monetary policy during 2012–14.

Suggested Citation

  • John Silvia & Azhar Iqbal, 2015. "An Ordered Probit Approach to Predicting the Probability of Inflation/Deflation," Business Economics, Palgrave Macmillan;National Association for Business Economics, vol. 50(1), pages 12-19, January.
    • Handle: RePEc:pal:buseco:v:50:y:2015:i:1:p:12-19
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    Citations

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    Cited by:

    1. Azhar Iqbal & John E. Silvia, 2016. "Does Deflation Threaten the Global Economy?," Global Economy Journal (GEJ), World Scientific Publishing Co. Pte. Ltd., vol. 16(2), pages 189-212, June.
    2. Azhar Iqbal & John E. Silvia, 2016. "Does Deflation Threaten the Global Economy?," Global Economy Journal (GEJ), World Scientific Publishing Co. Pte. Ltd., vol. 16(2), pages 189-212, June.
    3. Sam Bullard & Azhar Iqbal & John Silvia, 2016. "A New Framework to Estimate the Near-Term Path of the Fed Funds Rate," Business Economics, Palgrave Macmillan;National Association for Business Economics, vol. 51(4), pages 239-247, October.
    4. Azhar Iqbal & John Silvia, 2016. "Is Predicting Recessions Enough?," Business Economics, Palgrave Macmillan;National Association for Business Economics, vol. 51(4), pages 248-259, October.

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