Bananas and Petrol: Further Evidence on the Forecasting Accuracy of the ABS ‘Headline’ and ‘Underlying’ Rates of Inflation

In the light of the topical nature of ‘bananas and petrol’ being blamed for driving much of the inflationary pressures in Australia during 2006, the ‘headline’ and ‘underlying’ rates of inflation are scrutinised in terms of forecasting accuracy. A general structural time-series modelling strategy is then employed to estimate models for both types of Consumer Price Index (CPI) measures. From this, out-of-sample forecasts are generated from the various models. The underlying forecasts are subsequently adjusted to facilitate comparison to the headline forecasts. Having completed that, the Ashley, Granger and Schmalensee (1980) AGS test is performed to find out if there is a statistically significant difference between the root mean square errors (RMSEs) of the two models. The results lend weight to the recent findings of Song (2005), insofar that forecasting models using underlying rates are not systematically inferior to those based on the headline rate of inflation. In fact, strong evidence is found that underlying measures produce superior forecasts. JEL Classification Number: C53, E17