To illustrate, consider the models we use to forecast inflation. One approach is an extension of the Phillips Curve, that I was discussing above when talking about the NAIRU, where inflation is a function of spare capacity in the labour market, import prices and inflation expectations.
Another approach is to model inflation as a mark-up over input costs, such as growth in labour costs and import prices. ‘Bottom-up’ approaches are also used; for example, forecasting non-tradable and tradable inflation separately, and aggregating those to get a forecast for overall inflation. We can also use time series techniques to estimate the data-generating process only using the inflation data itself.