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Inflation forecasts, monetary policy and unemployment dynamics: evidence from the US and the euro area

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Author Info
Matteo Ciccarelli () (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
Carlo Altavilla () (University of Naples "Parthenope", Via Medina 40, 80133 Naples, Italy.)

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Abstract

This paper explores the role that inflation forecasts play in the uncertainty surrounding the estimated effects of alternative monetary rules on unemployment dynamics in the euro area and the US. We use the inflation forecasts of 8 competing models in a standard Bayesian VAR to analyse the size and the timing of these effects, as well as to quantify the uncertainty relative to the different inflation models under two rules. The results suggest that model uncertainty can be a serious issue and strengthen the case for a policy strategy that takes into account several sources of information. We find that combining inflation forecasts from many models not only yields more accurate forecasts than those of any specific model, but also reduces the uncertainty associated with the real effects of policy decisions. These results are in line with the model-combination approach that central banks already follow when conceiving their strategy. JEL Classification: C53; E24; E37.

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Paper provided by European Central Bank in its series Working Paper Series with number 725.

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Length: 39 pages
Date of creation: Feb 2007
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Handle: RePEc:ecb:ecbwps:20070725

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Keywords: Inflation forecasts unemployment model uncertainty.

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  1. Erwan Gautier & Ignacio Hernando & Philip Vermeulen & Daniel Dias & Maarten Dossche & Roberto Sabbatini & Harald Stahl, 2007. "Price setting in the euro area: some stylised facts from individual producer price data," Working Paper Series 727, European Central Bank. [Downloadable!]
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