Business Commons^™

Simulations Illustrate Flaw In Inflation Models, Peter L. D'Antonio Ph.D.

Faculty Works: Business (1973-2022)

This study questions the basic assumption of standard inflation models that there are only two forces driving price changes - underlying inflation and short-term noise. Specifically, the paper analyzes the distributions of individual price changes to shed light on an apparent contradiction: individual price changes are extremely dispersed, while measured inflation, the aggregate of individual price changes, remains relatively steady. Monte Carlo simulations demonstrate that the standard inflation model is inconsistent with this observation. The author reintroduces a new inflation model that explicitly accounts for the possibility of a third price-change driver - long-term sector-specific forces. Simulations show that the …