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Measures of Underlying Inflation in the Euro Area

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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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Related research

Keywords: Economic models; inflation; monetary policy; monetary aggregates; inflation dynamics; central bank; money stock; inflation forecasts; monetary fund; inflationary pressures; price level; money demand; quantity theory of money; average inflation; inflation process; inflation targeting; inflationary pressure; national bank; quantity theory; monetary policy reaction function; inflation rate; lower inflation; theory of money; relative prices; price stability; monetary policy decision;

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References

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  1. Nicoletti-Altimari, Sergio, 2001. "Does money lead inflation in the euro area?," Working Paper Series, European Central Bank 0063, European Central Bank.
  2. Forni, Mario & Hallin, Marc & Lippi, Marco & Reichlin, Lucrezia, 1999. "The Generalized Dynamic Factor Model: Identification and Estimation," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2338, C.E.P.R. Discussion Papers.
  3. Hendry, David F. & Hubrich, Kirstin, 2006. "Forecasting economic aggregates by disaggregates," Working Paper Series, European Central Bank 0589, European Central Bank.
  4. Hahn, Elke, 2002. "Core inflation in the euro area: An application of the generalized dynamic factor model," CFS Working Paper Series 2002/11, Center for Financial Studies (CFS).
  5. 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, MIT Press, vol. 4(2-3), pages 585-593, 04-05.
  6. O'Reilly, Gerard & Whelan, Karl, 2004. "Has euro-area inflation persistence changed over time?," Working Paper Series, European Central Bank 0335, European Central Bank.
  7. C.K. Folkertsma & K. Hubrich, 2001. "Performance of core inflation measures," DNB Staff Reports (discontinued), Netherlands Central Bank 63, Netherlands Central Bank.
  8. Michael F. Bryan & Stephen G. Cecchetti & Rodney L. Wiggins II, 1997. "Efficient Inflation Estimation," NBER Working Papers 6183, National Bureau of Economic Research, Inc.
  9. Timmermann, Allan G, 2005. "Forecast Combinations," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5361, C.E.P.R. Discussion Papers.
  10. repec:nsr:niesrd:249 is not listed on IDEAS
  11. Cristadoro, Riccardo & Forni, Mario & Reichlin, Lucrezia & Veronese, Giovanni, 2001. "A Core Inflation Index for the Euro Area," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3097, C.E.P.R. Discussion Papers.
  12. Danny Quah & Danny Quah & Shaun P. Vahey, 1995. "Measuring Core Inflation," CEP Discussion Papers, Centre for Economic Performance, LSE dp0254, Centre for Economic Performance, LSE.
  13. Quah, Danny, 1995. "Measuring Core Inflation," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1153, C.E.P.R. Discussion Papers.
  14. Juan-Luis Vega & Mark A. Wynne, 2002. "A first assessment of some measures of core inflation for the euro area," Working Papers, Federal Reserve Bank of Dallas 0205, Federal Reserve Bank of Dallas.
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Cited by:
  1. Emil Stavrev & Helge Berger, 2012. "The information content of money in forecasting euro area inflation," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 44(31), pages 4055-4072, November.

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