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Do monetary indicators lead euro area inflation?

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Author Info
Boris Hofmann () (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
Abstract

This paper assesses the performance of monetary indicators as well as of a large range of economic and financial indicators in predicting euro area HICP inflation out-of-sample over the period first quarter 1999 till third quarter 2006 considering standard bivariate forecasting models, factor models, simple combination forecasts as well as trivariate two-pillar Phillips Curve forecasting models using both ex-post revised and real-time data. The results suggest that the predictive ability of money-based forecasts relative to a simple random walk benchmark model was high at medium-term forecasting horizons in the early years of EMU, but has substantially deteriorated recently. A significantly improved forecasting performance vis-à-vis the random walk can, however, be achieved based on the ECB’s internal M3 series corrected for the effects of portfolio shifts and by combining monetary and economic indicators. JEL Classification: E31, E40, C32.

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Paper provided by European Central Bank in its series Working Paper Series with number 867.

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Length: 51 pages
Date of creation: Feb 2008
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Handle: RePEc:ecb:ecbwps:20080867

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Keywords: Euro area; inflation; leading indicators; money.;

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  2. Francis X. Diebold & Jose A. Lopez, 1996. "Forecast Evaluation and Combination," NBER Technical Working Papers 0192, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Jean Boivin & Serena Ng, 2005. "Understanding and Comparing Factor-Based Forecasts," NBER Working Papers 11285, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Assenmacher-Wesche, Katrin & Gerlach, Stefan, 2006. "Interpreting Euro Area Inflation at High and Low Frequencies," CEPR Discussion Papers 5632, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Claus Brand & Nuno Cassola, 2000. "A money demand system for Euro area M3," Working Paper Series 39, European Central Bank. [Downloadable!]
  6. Paul De Grauwe & Magdalena Polan, 2005. "Is Inflation Always and Everywhere a Monetary Phenomenon?," Scandinavian Journal of Economics, Blackwell Publishing, vol. 107(2), pages 239-259, 06. [Downloadable!] (restricted)
  7. Andrew Atkeson & Lee E. Ohanian., 2001. "Are Phillips curves useful for forecasting inflation?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-11. [Downloadable!]
  8. Elena Angelini & Jerome Henry & Ricardo Mestre, 2001. "Diffusion index-based inflation forecasts for the euro area," Working Paper Series 061, European Central Bank. [Downloadable!]
  9. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 253-63, July.
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  10. Alessandro Calza & Dieter Gerdesmeier & Joaquim Vieira Ferreira Levy, 2001. "Euro Area Money Demand: Measuring the Opportunity Costs Appropriately," IMF Working Papers 01/179, International Monetary Fund.
  11. Günter Coenen & Juan-Luis Vega, 1999. "The demand for M3 in the euro area," Working Paper Series 6, European Central Bank. [Downloadable!]
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