Forecasting inflation generally improves financial planning in both the corporate and private sectors. Inflation affects actual cost of expenses and stock valuations on the corporate level. Forecasting changes can therefore help investors understand risks and hedge investments. Forecasting inflation also aids in the creation and evaluation of monetary policy.
Private banks need to forecast inflation in order to keep their investments profitable. Inflation can cause the bank’s return on fixed rate loans to decrease, sometimes making the loan unprofitable. Forecasting inflation can therefore help banks achieve their operating capital requirements.
Forecasting inflation in corporations can help businesses prepare for accurately calculating expenditures. Being prepared for inflationary shifts can lead companies to stock raw materials at a cheaper price, avoiding price increases in periods of inflation. Forecasting inflation can also prepare businesses for potential needs in wage shifts, signaling necessary adjustments in human resources.
Businesses that do not account for forecasted fluctuations in inflation can experience shifts in strategic growth and falling stock prices. Demand decreases due to increased prices often result from an increase in the price of raw materials. This decrease in available cash, coupled with the higher cost of loans in inflationary periods, often slows growth strategy. The combination of a decrease in cash flows and growth process can have a negative effect on stock prices.
Choosing optimal refinancing periods and appropriate mortgage rate decisions are two benefits of forecasting inflation for individuals. Forecasting inflation can give investors information about whether or not to invest in the bond market, as fixed rate bonds lose value in periods of inflation. Portfolio diversification can also help counter the effects of inflation.
If individuals do not account for potential inflation, a decline in purchasing power can be experienced. People who live off of their retirement or their savings account, for example, rely on their balance and on current interest rates. Inflation can push prices up, making currency today worth less in the future and rendering their fixed income less valuable.
Monetary policy decision making also relies on forecasting inflation. Understanding inflationary potential can help policy makers estimate the economic effects of their policies. For example, high inflation can affect the value of domestic products in an international market. If this inflation is not experienced worldwide, the increase in prices decreases the competitive power of said domestic product.
One tool that helps forecast inflation is the Moore Inflation predictor (MIP), used to forecast inflation up to one year ahead. The MIP is a technical predictor that has been very successful in showing potential values for future inflation. It takes the form of a graphical representation. Political shifts, international tensions, and disasters cannot be factored into the MIP, however, and these are all factors that can drastically affect inflation.