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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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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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  1. Forni, Mario & Hallin, Marc & Lippi, Marco & Reichlin, Lucrezia, 2005. "The Generalized Dynamic Factor Model: One-Sided Estimation and Forecasting," Journal of the American Statistical Association, American Statistical Association, vol. 100, pages 830-840, September.
  2. Danny Quah & Danny Quah & Shaun P. Vahey, 1995. "Measuring Core Inflation," CEP Discussion Papers dp0254, Centre for Economic Performance, LSE.
  3. Stock, James H. & Watson, Mark W., 1999. "Forecasting inflation," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 293-335, October.
  4. 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.
  5. Michael F. Bryan & Stephen G. Cecchetti, 1996. "Inflation and the Distribution of Price Changes," NBER Working Papers 5793, National Bureau of Economic Research, Inc.
  6. Michael F. Bryan & Stephen G. Cecchetti & Rodney L. Wiggins II, 1997. "Efficient Inflation Estimation," NBER Working Papers 6183, National Bureau of Economic Research, Inc.
  7. Marco Aiolfi & Carlos Capistrán & Allan Timmermann, 2010. "Forecast Combinations," CREATES Research Papers 2010-21, School of Economics and Management, University of Aarhus.
  8. Forni, Mario & Hallin, Marc & Lippi, Marco & Reichlin, Lucrezia, 2002. "Do Financial Variables Help Forecasting Inflation and Real Activity in the Euro Area?," CEPR Discussion Papers 3146, C.E.P.R. Discussion Papers.
  9. Mario Forni & Marc Hallin & Lucrezia Reichlin & Marco Lippi, 2000. "The generalised dynamic factor model: identification and estimation," ULB Institutional Repository 2013/10143, ULB -- Universite Libre de Bruxelles.
  10. C.K. Folkertsma & K. Hubrich, 2000. "Performance of core inflation measures," WO Research Memoranda (discontinued) 639, Netherlands Central Bank, Research Department.
  11. repec:nsr:niesrd:249 is not listed on IDEAS
  12. Gerard O'Reilly & Karl Whelan, 2005. "Has Euro-Area Inflation Persistence Changed Over Time?," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 709-720, November.
  13. Nicoletti-Altimari, Sergio, 2001. "Does money lead inflation in the euro area?," Working Paper Series 0063, European Central Bank.
  14. 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).
  15. Quah, Danny, 1995. "Measuring Core Inflation," CEPR Discussion Papers 1153, C.E.P.R. Discussion Papers.
  16. 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.
  17. Cristadoro, Riccardo & Forni, Mario & Reichlin, Lucrezia & Veronese, Giovanni, 2001. "A Core Inflation Index for the Euro Area," CEPR Discussion Papers 3097, C.E.P.R. Discussion Papers.
  18. Michael F. Bryan & Stephen G. Cecchetti, 1994. "Measuring Core Inflation," NBER Chapters, in: Monetary Policy, pages 195-219 National Bureau of Economic Research, Inc.
  19. Hendry, David F & Hubrich, Kirstin, 2006. "Forecasting Economic Aggregates by Disaggregates," CEPR Discussion Papers 5485, C.E.P.R. Discussion Papers.
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