The Historical and Recent Behavior of Goods and Services Inflation

[...]In this article, we model the relationship between goodsinflation and services inflation from 1967:2 to 2002:4. To helpinform the inflation debate, we then use our results to forecastinflation for 2003. The specific inflation series that we model isthe quarterly change (at an annual rate) of the core personalconsumption expenditures (PCE) deflator, or the PCE deflatorexcluding its food and energy components.We find that over the past thirty-five years, core PCE goodsinflation and core PCE services inflation have experiencedpermanent increases and reductions, but these shifts havemoved roughly in tandem.2 That is, the difference, or “gap,”between the two inflation rates exhibits a strong tendency torevert back to a constant equilibrium value in the long run, aprocess known as mean reversion. In the short run, however,the gap displays cyclical fluctuations, tending to widen aroundbusiness cycle peaks and narrow during recessions and theearly stages of recovery. When the gap is above its long-runvalue, as it currently is, equilibrium is restored through anincrease in core goods inflation and a decline in core servicesinflation.[...]