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Measures of underlying inflation in the euro area: assessment and role for informing monetary policy

  • Emil Stavrev

    ()

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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File URL: http://hdl.handle.net/10.1007/s00181-009-0263-0
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Article provided by Springer in its journal Empirical Economics.

Volume (Year): 38 (2010)
Issue (Month): 1 (February)
Pages: 217-239

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Handle: RePEc:spr:empeco:v:38:y:2010:i:1:p:217-239
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  1. Michael F. Bryan & Stephen G. Cecchetti, 1999. "Inflation And The Distribution Of Price Changes," The Review of Economics and Statistics, MIT Press, vol. 81(2), pages 188-196, May.
  2. Forni, Mario & Hallin, Marc & Lippi, Marco & Reichlin, Lucrezia, 1999. "The Generalized Dynamic Factor Model: Identification and Estimation," CEPR Discussion Papers 2338, C.E.P.R. Discussion Papers.
  3. 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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  8. Michael F. Bryan & Stephen G. Cecchetti, 1993. "Measuring Core Inflation," NBER Working Papers 4303, National Bureau of Economic Research, Inc.
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  16. repec:nsr:niesrd:249 is not listed on IDEAS
  17. Mario Forni & Marc Hallin & Marco Lippi & Lucrezia Reichlin, 2005. "The generalised dynamic factor model: one sided estimation and forecasting," ULB Institutional Repository 2013/10129, ULB -- Universite Libre de Bruxelles.
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