When the post-pandemic economy entered uncharted territory, economic models based on historical data struggled to make accurate forecasts, highlighting the need for flexibility during abnormal times. This observation comes from a new report by the Federal Reserve Bank of Cleveland.
Cleveland Fed research economists Paolo Gelain and Pierlauro Lopez described how their model began to falter in mid-2022 after the Federal Open Market Committee started raising interest rates to combat inflation. The model had predicted that unemployment would rise as inflation and job vacancies fell, but unemployment remained steady instead.
To understand this period better, Gelain and Lopez adjusted their model. They cited prior research on economic behavior during abnormal times and made wages and prices more flexible within their model. Additionally, they facilitated quicker job filling by employers in the model.
“These modifications enhance the model’s alignment with observed economic data, and they help us understand how and why the disinflation of 2023 was not accompanied by higher unemployment rates. This analysis underscores the need for models and their users to be flexible to respond to unprecedented economic conditions,” they wrote.
The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that, along with the Board of Governors in Washington DC, comprise the Federal Reserve System. As part of the US central bank, it participates in formulating national monetary policy, supervises banking organizations, provides payment services to financial institutions and the US Treasury, and supports various Federal Reserve operations system-wide.
In addition to its primary functions, the Cleveland Fed supports community well-being across Ohio, western Pennsylvania, eastern Kentucky, and northern West Virginia through extensive research, outreach programs, and educational activities.
Dani Carlson can be contacted for further information at Dani.Carlson@clev.frb.org or 216.672.1264.
