In this Economic Letter, we systematically study the inflation forecasting accuracy of a large set of slack measures. In other words, inflation rises as the amount of economic “slack” falls.Īlthough the concept of slack may seem straightforward, finding the best proxy to measure it is notoriously difficult. The underlying intuition is that, as the economy heats up, demand can exceed capacity, causing upward pressure on prices and thus higher inflation. The main framework to explain inflation dynamics, known as the Phillips curve, links inflation to the amount of unused production capacity in the economy. Understanding how inflation responds to economic conditions is important for monetary policymakers. Recent elevated values of these measures of labor market tightness suggest greater inflation pressure than is implied by the unemployment rate alone. ![]() Estimates suggest that direct measures of labor market tightness, such as the ratio of job vacancies to unemployment or the rate of employee job switching, provide more accurate forecasts than commonly used measures, such as the unemployment rate or the output gap. Different ways of measuring the economy’s unused capacity, or slack, can result in varying inflation forecasts.
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