Inflation expectations and energy price forecasting

• Date: 01 March 2014
• DOI: http://doi.org/10.1111/opec.12016
• Published date: 01 March 2014
• Author: Hamid Baghestani

Inflation expectations and energy

price forecasting

Hamid Baghestani*

*Professor, Department of Economics, School of Business and Management, American University of

Sharjah, PO Box 26666, Sharjah, UAE. Email: baghesta@ms.com

Abstract

In this study, weask whether US consumers’ inflation expectations provide useful information for

accurately predicting the direction of change in energyprices. As such, we set up a forecasting model

to generate the one-, two- and three-quarter-ahead random walk forecasts of crude oil, gasoline and

heating oil prices. For the period 1987–2012, our test results revealthat the forecasts are free of sys-

tematic bias and thus imply symmetric loss. Also, they are generally efficient, where efficiency

means the forecast error is uncorrelated with its own past values. The random walk forecast errors

are, however, correlated with the change in inflation expectations (measured by the data from the

Michigan Surveys of Consumers). Thus, weconclude such expectations may contain useful predic-

tive information for crude oil, gasoline and heating oil prices. Consistent with this conclusion, we

show that the change in inflation expectations accurately predicts the direction of change in such

energy prices for 1987–2012.

1. Introduction

The importance of oil in the world economy has long been recognised.A global oil market

with reasonably stable prices is essential for sound policy making in both oil-exporting

and oil-importing countries. Oil-exporting countries rely on oil revenues to meet their

budgetary needs, and oil-importing countries rely on crude oil as the main source of

energy.A sharp decline in crude oil prices, similar to that in 1998, can cause serious budg-

etary deficits and thus delay economic growth in oil-exporting countries. A substantial

increase in oil prices, however, can cause stagflation in oil-importing countries by

adversely affecting economic growth and accelerating inflation. To help with decision-

making, policy-makers would liketo be able to predict the direction of change in crude oil

and distillates prices, if even on a short-term time horizon. This is also true for decision-

makers in the petroleum and petrochemical industries.

JEL Classification Codes: Q47, Q48

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