Do Asset Prices Help to Predict Consumer Price Inflation

With goods prices being sticky, monetary impulses are initially transmitted to the real economy via changes in asset prices; and asset price fluctuations can independently affect monetary and real developments. Most empirical models try to incorporate such monetary-asset price interactions by the inclusion of a short-term interest rate and the exchange rate, but there are good reasons to doubt the sufficiency of this. Here we examine whether the predictive power of a reduced form equation for inflation, including standard explanatory variables, can be improved by adding other asset price variables, i.e. the changes in housing and equity prices and a yield spread. In our cross-country time series exercise, we find that housing price movements do provide useful extra information on future inflation, with equity prices and the yield spread being somewhat less informative.