Two
years ago we presented a model for the rate of inflation in the UK and a prediction
for 2010-2020. Actual rate in 2011 and 2012 was very close to the predicted one
as Figure 1 demonstrates. There is no change to the model and we foresee
another ten years of a reactively large (CPI) inflation rate in the UK – nearly
3% per year. In 2013, the predicted rate is 2.9%.
According to our concept,
the original paper was published by the Euro Area Business Cycle Network, there exists
a long-term equilibrium link between price inflation, CPIt, unemployment, ut,
and the rate of change of labour force, lt=dLF/LFdt.
We follow up our predictions for many counties in this blog. The UK is one of the world biggest economies
with a relatively good statistics started chiefly from 1973. It is a major challenge to model inflation in
the UK using our approach.
There is a structural break in the link between
three defining variables in 1985, which is purely artificial and induced by the
change in measurement units and definitions. Accordingly, we have to distinguish
two periods to fit observations: before and after 1985:
CPIt = 1.0lt + ut - 0.046; t>1985
CPIt = -1.0lt -1.7 ut + .025; t<1985 (1)
For both periods, inflation
does not lag behind unemployment and lt.
Figure 1 presents the observed and predicted CPI curves, all variables were
obtained from the OECD database in 2013. All in all, the predictive power of
the model is good and timely fits major peaks and troughs. The change from
negative to positive linear coefficient in 1985 needs a special explanation.
But such effects were observed in other developed countries as well.
The NSO's labour
force projection helps to predict the future inflation. Since the inflow
of new employees is still positive, lt >0, and the rate of unemployment does not foresees any
dramatic decline in the long run one can be sure that inflation will be
positive in the near future, as Figure 2 predicts.
Figure 1. The predicted and measured rate of consumer
price inflation (CPI) in the UK.
Figure 2. The predicted rate of CPI inflation in the UK between
2008 and 2020 estimated from the labour force projection by the NSO.
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