The informational content of the term spread in forecasting the US inflation rate : a nonlinear approach

Abstract

The difficulty in modelling inflation and the significance in discovering the underlying data-generating process of in-flation is expressed in an extensive literature regarding inflation forecasting. In this paper we evaluate nonlinearmachine learning and econometric methodologies in forecasting US inflation based on autoregressive and structuralmodels of the term structure. We employ two nonlinear methodologies: the econometric least absolute shrinkageand selection operator (LASSO) and the machine-learning support vector regression (SVR) method. The SVR hasnever been used before in inflation forecasting considering the term spread as a regressor. In doing so, we use a longmonthly dataset spanning the period 1871:1–2015:3 that covers the entire history of inflation in the US economy. Forcomparison purposes we also use ordinary least squares regression models as a benchmark. In order to evaluate thecontribution of the term spread in inflation forecasting in different time periods, we measure the out-of-sample fore-casting performance of all models using rolling window regressions. Considering various forecasting horizons, theempirical evidence suggests that the structural models do not outperform the autoregressive ones, regardless of themodel’s method. Thus we conclude that the term spread models are not more accurate than autoregressive modelsin inflation forecasting.