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Measures of Underlying Inflation in the Euro Area: Assessment and Role for Informing Monetary Policy

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  • Emil Stavrev

Abstract

The paper evaluates the 24-month ahead inflation forecasting performance of various indicators of underlying inflation and structural models. The inflation forecast errors resulting from model misspecification are larger than the errors resulting from forecasting of exogenous variables. Also, measures derived using the generalized dynamic factor model (GDFM) overperform other measures over the monetary policy horizon and are leading indicators of headline inflation. Trimmed means, although weaker than GDFM indicators, have good forecasting performance, while indicators by permanent exclusion underperform but provide useful information about short-term dynamics. The forecasting performance of theoretically-founded models that relate monetary aggregates, the output gap, and inflation improves with the time horizon but generally falls short of that of the GDFM. A composite measure of underlying inflation, derived by averaging the statistical indicators and the model-based estimates, improves forecast accuracy by eliminating bias and offers valuable insight about the distribution of risks.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/197.

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Length: 37
Date of creation: 01 Aug 2006
Date of revision:
Handle: RePEc:imf:imfwpa:06/197

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Keywords: Economic models;

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References

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  1. Marco Aiolfi & Carlos Capistrán & Allan Timmermann, 2010. "Forecast Combinations," Working Papers 2010-04, Banco de México.
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  16. Stephen Hall & James Mitchell, 2004. "Density Forecast Combination," NIESR Discussion Papers 249, National Institute of Economic and Social Research.
  17. Juan-Luis Vega & Mark A. Wynne, 2002. "A first assessment of some measures of core inflation for the euro area," Working Papers 0205, Federal Reserve Bank of Dallas.
  18. Filippo Altissimo & Laurent Bilke & Andrew Levin & Thomas Mathä & Benoit Mojon, 2006. "Sectoral and Aggregate Inflation Dynamics in the Euro Area," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 585-593, 04-05.
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Cited by:
  1. Emil Stavrev & Helge Berger, 2008. "The Information Content of Money in Forecasting Euro Area Inflation," IMF Working Papers 08/166, International Monetary Fund.

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