Weaknesses of the output gap in forecasting inflation
02 July 2020 | by Peter Warburton
If inflation forecasting were easy, almost everyone would succeed in this endeavour. The record shows otherwise. Simple models of the inflationary process are essential teaching tools but have serious deficiencies when deployed as forecasting tools. Neither money supply growth (however defined) nor the Keynesian output gap is a reliable guide to the inflationary outlook amidst monetary regime change. The output gap framework would have failed miserably in its predictions of inflation in the 1930s and the 1970s.