The New York Fed DSGE Model Forecast—December 2021

Marco Del Negro, Aidan Gleich, Shlok Goyal, Alissa Johnson, and Andrea Tambalotti

This post presents an update of the economic forecasts generated by the Federal Reserve Bank of New York’s dynamic stochastic general equilibrium (DSGE) model. We describe very briefly our forecast and its change since September 2021.

As usual, we wish to remind our readers that the DSGE model forecast is not an official New York Fed forecast, but only an input to the Research staff’s overall forecasting process. For more information about the model and variables discussed here, see our DSGE model Q & A.

The December 2021 model forecast is reported in the table below, alongside the one from September 2021, and depicted in the charts that follow. The forecast uses quarterly macroeconomic data released through 2021:Q3, augmented for 2021:Q4 with the median forecasts for real GDP growth and core PCE inflation from the Philadelphia Fed’s November Survey of Professional Forecasters (SPF) release, as well as the yields on 10-year Treasury securities and Baa corporate bonds based on 2021:Q4 averages up to November 29.

Compared to September, the model projects somewhat weaker GDP growth in 2021 and 2022, together with slightly higher inflation through the forecast horizon. This unfavorable combination of forecast revisions mostly reflects two factors. The first factor is a continuation of the cost-push shock dynamics that have prevailed over the past few quarters, resulting in higher inflation and lower output. The second factor is tighter monetary policy in 2022 and 2023, as a response to the higher realized and forecasted inflation.

Following a 2020 dominated by the extreme swings in economic activity related to COVID-19, the key economic development of 2021 according to the model has been a series of large and persistent cost-push shocks. These shocks have raised inflation by about 2 percentage points so far in 2021 and are expected to fade only gradually over the course of 2022. In addition, the model attributes part of the elevated inflation readings in 2021 to a shock that increases the observed price level on impact, but that subsequently reduces inflation as its temporary level effect on prices fades. This price-level shock captures the effect on overall inflation of the extreme spikes in the prices of some goods, especially durables, which are expected to reverse at least in part. The model reads the data released since September as consistent with this environment, with inflation surprising on the upside and economic activity weaker than expected in the second half of the year, although strengthening in Q4. As a result, the SPF nowcast for 2021 has core PCE inflation at 3.9 percent and GDP growth at 4.8 percent, down from 5.3 percent in September.

In 2022, the model projects inflation to moderate to 2.2 percent, the same as in September, with a further decline to 2 percent in 2023 and 2024, which is marginally stronger than the September expectation. This return of inflation to mandate-consistent levels reflects the fading effect of cost-push shocks, whose contribution to inflation remains positive through 2022, and the disappearance of price-level shocks, as well as the response of monetary policy to these developments. Starting in 2020:Q4, such policy response follows average inflation targeting (AIT), reflecting the changes in the FOMC monetary policy strategy announced in August 2020. 

On balance, the near-term reaction of monetary policy to economic developments described above generates a modest drag on real activity. Coupled with the payback from the positive boost to GDP growth provided by the accommodative policy stance adopted so far, this drag pushes GDP growth below potential in 2023 and 2024. Compared to September, however, GDP growth is higher in 2023 and 2024, at 1.2 and 1.4 percent, respectively. This improvement in part reflects the more gradual tightening of policy in the later years.

Estimates of the real natural rate and its future evolution are broadly similar to those in September, with the natural rate predicted to be -0.4 percent by the end of 2021 and rising slowly to 0.5 percent in 2024.

Forecast Comparison

	2021		2022		2023		2024
	Dec	Sep	Dec	Sep	Dec	Sep	Dec	Sep
GDP growth (Q4/Q4)	4.8 (4.6, 5.0)	5.3 (4.3, 6.4)	1.6 (-0.5, 3.7)	1.7 (-1.1, 4.5)	1.2 (-0.7, 3.1)	0.8 (-2.1, 3.8)	1.4 (-0.5, 3.3)	0.7 (-2.8, 4.1)
Core PCE inflation (Q4/Q4)	3.9 (3.6, 4.2)	3.8 (3.6, 4.0)	2.2 (1.4, 3.0)	2.2 (1.5, 3.0)	2.0 (1.1, 2.9)	1.9 (1.1, 2.7)	2.0 (1.1, 3.0)	1.8 (1.1, 2.6)
Real natural rate of interest (Q4)	-0.4 (-1.5, 0.6)	-0.2 (-1.4, 1.0)	0.2 (-1.2, 1.6)	0.3 (-1.2, 1.8)	0.4 (-1.1, 2.0)	0.5 (-1.1, 2.1)	0.5 (-1.1, 2.2)	0.6 (-1.0, 2.3)

Forecasts of Output Growth

Forecasts of Inflation

Real Natural Rate of Interest

How to cite:
Marco Del Negro, Aidan Gleich, Shlok Goyal, Alissa Johnson, and Andrea Tambalotti, “The New York Fed DSGE Model Forecast—December 2021,” Federal Reserve Bank of New York Liberty Street Economics, December 17, 2021, https://libertystreeteconomics.newyorkfed.org/2021/12/the-new-york-fed-dsge-model-forecast-december-2021.html.

Related Reading
The New York Fed DSGE Model Forecast—September 2021
The New York Fed DSGE Model Forecast—June 2021
The New York Fed DSGE Model Forecast—March 2021
The New York Fed DSGE Model
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Disclaimer
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.