Is core CPI inflation in a new regime? Results using a Markov switching model (pioneered by James Hamilton).

Figure 1: Core CPI inflation m/m in log differences (blue). NBER defined peak-to-trough recession dates shaded gray. Source: BLS, NBER, and author’s calculations.

Applying a simple Markov switching 2-regime estimation method (implemented in EViews, using default settings, allowing for different variances) over the 1960-2022 period yields the following estimate.

This estimate yields the following estimates of regimes (filtered, smoothed):

The estimates indicate a 30% probability of being in the low inflation regime. The results are somewhat sensitive to assumptions regarding the variances in the two regimes. Imposing a restriction of common variances leads to the following estimated probabilities of being in the two regimes.

Imposing the restriction of common variances, the indications are much stronger for a switch to the low inflation regime.

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