Explaining and Forecasting Euro Area Inflation: the Role of Domestic and Global Factors

In this paper, we study the fit and the predictive performance of the Phillips curve for euro area inflation with regard to different inflation series, time periods and predictor variables, notably different global factors. We compare the relative performance of a large set of alternative global factors in the Phillips curve, such as commodity prices, import prices, global consumer inflation, global economic slack and foreign demand. We find that traditional global indicators such as oil prices and import prices provide more accurate information for euro area headline inflation than global slack measures. In what regards the forecast ability of the Phillips curve for headline inflation, we show that it is unstable and depends strongly on the time period. Global factors provide only limited additional information for forecasting. In addition, we explore whether domestic demand and global factors are useful for analysing the entire conditional distribution of euro area inflation. We find that their impact varies across inflation quantiles (low vs. high inflation) and that inflation is more persistent at the low end of the distribution. We provide evidence that quantile information can lead to more accurate forecasts in periods of persistently low inflation.