A twelve-month moving-average filter for inflation direction

Two monthly cost-pressure inputs

The filter is assembled from two monthly inputs, capacity utilization and the unemployment rate. Each series is subtracted from its own twelve-month simple moving average, the unweighted mean of the latest twelve monthly observations of that series, used as the local baseline subtracted from the current reading.

Capacity utilization and unemployment are used as stand-ins for materials-market and labor-market cost pressure, the two primary cost channels named in the construction.

Lookback, inversion, and equal-weight scale

The capacity-utilization deviation is the gap between the current capacity-utilization rate and its twelve-month simple moving average. That gap stands in for materials-market cost pressure.

The scaled-unemployment oscillator is the gap between the unemployment rate and its twelve-month simple moving average, multiplied by negative two and a half. That step inverts the labor term and gives it comparable weight to the capacity-utilization deviation.

The sampling interval is monthly and the lookback is twelve months. Editorial: the lookback, the inversion, and the equal-weight scale are the construction contract that lets the filter be rebuilt as an explicit baseline.

How to read the signed inflation filter

The two deviations are combined into a monthly signed inflation filter. Editorial: only the sign of that sum is read as the forecast.

A reading above zero is interpreted as a forecast that the inflation rate will rise from its then-current level. A reading below zero is interpreted as a forecast that the rate will fall.

The constructed series is presented as a directional forecast of the inflation rate, not as a forecast of the inflation level itself. Inflation in the comparison is measured as the year-over-year consumer-price rate, the percentage change in the Consumer Price Index versus the same month a year earlier.

Comparison overlay and stated leads

Unemployment is inverted on the comparison chart so its peaks and troughs can be aligned visually with capacity utilization and the inflation rate. Capacity utilization and unemployment are described as tending to turn before the inflation rate.

The illustrated overlay advances the constructed series by six months. The notes give an average lead versus the consumer-price trend of seven to nine months, and a shorter five-to-seven-month lead in the later decade of the sample.