Forecasting Inflation in a Data-Rich Environment: The Benefits of Machine Learning Methods - Forecasting Inflation in a Data-Rich Environment: The Benefits of Machine Learning Methods - Central Bank of Chile
The Working Paper Series of the Central Bank of Chile disseminates economic research conducted by Central Bank staff or third parties under the sponsorship of the Bank. The purpose of the series is to contribute to the discussion of relevant issues and develop new analytical or empirical approaches in their analysis. The only aim of the Working Papers is to disseminate preliminary research for its discussion and comments. Publication of Working Papers is not subject to previous approval by the members of the Board of the Central Bank. The views and conclusions presented in the papers are exclusively those of the author(s) and do not necessarily reflect the position of the Central Bank of Chile or of the Board members.
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Inflation forecasting is an important but difficult task. Here, we explore advances in machine learning (ML) methods and the availability of new datasets to forecast US inflation. Despite the skepticism in the previous literature, we show that ML models with a large number of covariates are systematically more accurate than the benchmarks. The ML method that deserves more attention is the random forest model, which dominates all other models. Its good performance is due not only to its specific method of variable selection but also the potential nonlinearities between past key macroeconomic variables and inflation.