1. Global Analysts Eirik Skeid, Anders Graham, Bradley Moore, Matthew Scott Tor Seim, Steven Comstock

2. Project Purpose Investigate the correlation between USA’s unemployment and inflation rates. Construct a model which can be used for approximate inflation forecasting.

3. Outline Characterize the data Test for Unit Roots Pre-Whitten the time series Investigate Causality Bivariate Model Construction Remodel Forecast and Evaluate Results

4. DataTraces Inflation Calculation based on: CPI-CPI(-12) / CPI(-12). Unemployment Trace

5. Histograms Inflation: Multi-peaked Positively Skewed Slightly Kurtotic Not Normal Unemployment: Multi-peaked Not Normal

6. Correlograms InflationUnemployment Both appear to be random walks and require unit root test.

7. Unit Roots Tests InflationUnemployment Both are evolutionary.

8. Differencing Inflation Unemployment

9. Differenced Histograms Inflation: Kurtotic Not Normal Unemployment: Kurtotic Not normal

10. Differenced Inflation Correlogram Looks like a seasonal ARMA(2,2). The reason for the spike at 12 is because of the definition of inflation CPI- CPI(-12) / CPI(-12). It does not look over differenced.

11. Unemployment Correlogram

12. Granger Causality Test Results show one way causality, unemployment affects inflation

13. Cross Correlations

14. VAR Impulse Response

16. Inflation Model

17. Residuals Correlograms of the residuals and the squared residuals.

18. Forecasting of Inflation Tracking Plot Forecast

19. Model Improvement Removing imputed structure in CPI calculation. Old Equation: CPI-CPI(-12) / CPI(-12) New Equation: CPI-CPI(-1) / CPI(-1)

20. Data Identification TraceHistogram

21. Unit Root Test for CPI Data

22. Differenced CPI Data Stationary, yet not normal.

23. Granger causality test Unemployment seems to cause inflation but not the opposite

24. Estimation Output for Best Model

25. Forecasting

26. Recolored Forecast

27. Conclusion  The best model uses the CPI based on monthly changes instead of annual.  The coefficient on dunem is negative. So an increase in unemployment rate will result in a decrease in inflation, all else held constant.  This is correct according to macroeconomic theory. Inflation and unemployment rate are inversely related probably with a small lag, in our case 3 months. The inclusion of additional correlated variables could increase forecasting accuracy