A new indicator developed by the Federal Reserve Bank of San Francisco can improve inflation forecasts at one-year to three-year horizons by tracking which consumer spending categories are experiencing consecutive monthly price shocks. The Inflation Shock Momentum Index, described in an Economic Letter published this month by economists Kevin Lansing and Adam Hale Shapiro, monitors the shares of spending categories that register three straight months of positive or negative inflation surprises. The index has fluctuated above and below zero in recent months, signaling that inflation may remain near current levels in the near to medium term.
The index examines roughly 130 categories of goods and services in the personal consumption expenditures basket, classifying each based on whether it has experienced three consecutive positive or negative inflation shocks. The report finds that on average since 1969, around 20% of categories exhibit three consecutive positive shocks each month, while around 15% show three consecutive negative shocks. The index remained persistently positive during the late 1970s and early 1980s inflation surge, then turned sharply negative during the subsequent disinflation and stayed below zero into the 1990s as PCE inflation declined from around 5% in 1990 to 2% in 1999. During the pandemic era, the index rose rapidly during 2021 and 2022 as PCE inflation surged to a 40-year high of 7.24% in June 2022, then declined faster than PCE inflation itself and eventually turned negative. As of May 2026, the index value has been fluctuating around zero.
Out-of-sample forecasting tests show that including the index in forecasting models reduces forecast errors by approximately 5% to 10%, even after accounting for standard predictor variables like household inflation expectations, the vacancy-to-unemployment ratio, and oil prices. According to the authors, "the forecast improvement from including the ISMI is larger at longer horizons of two to three years," suggesting the index can detect slow-moving structural shifts in the underlying inflation process that other standard predictors may miss. A surprise increase in the index is associated with a 0.5 percentage point cumulative increase in the PCE price index after 36 months, with the index proving "particularly useful for detecting future disinflationary pressures," the report states.
The index responds to macroeconomic shocks in ways consistent with economic theory, supporting its reliability as a measure of underlying inflation behavior. When tested against monetary policy shocks aimed at reducing inflation, the index declines significantly and remains low for an extended period, capturing the well-documented effects of policy tightening that restrains demand. In contrast, the index increases significantly but for a shorter period in response to negative news about future oil supply, consistent with the transitory nature of typical supply shocks. The authors argue that distinguishing between upward versus downward inflation pressure, rather than simply gauging overall persistence, helps policymakers avoid two risks: falling behind the curve and allowing inflation expectations to become unanchored, or tightening prematurely and causing unnecessary output or employment losses.
The San Francisco Fed has launched a new data page with monthly updates of the Inflation Shock Momentum Index to help monitor inflation pressures in real time. The index's recent fluctuations around zero indicate that current inflation readings may persist in the near to medium term, offering policymakers an early-warning system for shifts in the underlying inflation environment that can improve monetary policy decisions.