furman5_Getty Images Yuichiro Chino_forecasting Getty Images Yuichiro Chino

Why Did Almost Nobody See Inflation Coming?

Forecasting inflation is a staple of macroeconomic modeling, yet virtually all economists’ predictions for the United States in 2021 were way off the mark. This dismal performance reflected a collective failure to take economic models seriously enough, as well as other analytical shortcomings.

CAMBRIDGE – In 2008, as the global financial crisis was ravaging economies everywhere, Queen Elizabeth II, visiting the London School of Economics, famously asked, “Why did nobody see it coming?” The high inflation of 2021 – especially in the United States, where the year-on-year increase in consumer prices reached a four-decade high of 7% in December – should prompt the same question.

Inflation is not nearly as bad as a financial crisis, particularly when price increases coincide with a rapid improvement in the economy. And whereas financial crises may be inherently unpredictable, forecasting inflation is a staple of macroeconomic modeling.

Why, then, did almost everyone get the US inflation story so wrong last year? A survey of 36 private-sector forecasters in May revealed a median inflation forecast of 2.3% for 2021 (measured by the core personal consumption expenditures price index, the US Federal Reserve’s de facto target gauge). As a whole, the group put a 0.5% chance on inflation exceeding 4% last year – but, by the core PCE measure, it looks set to be 4.5%.