A Core Inflation Indicator for the Euro Area

This paper proposes a new core inflation indicator for the euro area, obtained by 'cleaning' monthly price changes from short-run volatility, idiosyncratic, and measurement errors. We use a factor model to "project" monthly inflation on a large panel of time series. Exploiting multivariate information we obtain a satisfactory degree of smoothing without using backward looking moving averages, which induce a time delay in the signal. The indicator forecasts inflation and is a useful tool for policy makers. It outperforms other commonly used predictors at 6 months and longer horizons. It tracks past policy interventions of the ECB.

[1]  Marco Lippi,et al.  The Generalized Factor Model: Identification and Estimation , 2000 .

[2]  D. Brillinger.  Time series - data analysis and theory , 1981, Classics in applied mathematics.

[3]  J. Stock,et al.  Business Cycle Fluctuations in U.S. Macroeconomic Time Series , 1998 .

[4]  Marianne Baxter,et al.  Measuring Business Cycles: Approximate Band-Pass Filters for Economic Time Series , 1995, Review of Economics and Statistics.

[5]  M. Hallin,et al.  The Generalized Dynamic-Factor Model: Identification and Estimation , 2000, Review of Economics and Statistics.

[6]  James D. Hamilton.  Time Series Analysis , 1994 .

[7]  Ricardo Mestre,et al.  Diffusion Index-Based Inflation Forecasts for the Euro Area , 2002, SSRN Electronic Journal.

[8]  W. Newey,et al.  A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelationconsistent Covariance Matrix , 1986 .

[9]  Sergio Nicoletti Altimari,et al.  Does money lead inflation in the euro area , 2001 .

[10]  Thomas J. Sargent,et al.  Business cycle modeling without pretending to have too much a priori economic theory , 1976 .

[11]  Carmine Trecroci,et al.  The information content of M3 for future inflation in the Euro area , 2002 .

[12]  Stephen G. Cecchetti,et al.  The Consumer Price Index as a Measure of Inflation , 2005 .

[13]  Leading Indicators for Euro-Area Inflation and GDP Growth , 2003 .

[14]  Marco Lippi,et al.  THE GENERALIZED DYNAMIC FACTOR MODEL: REPRESENTATION THEORY , 2001, Econometric Theory.

[15]  J. Stock,et al.  Forecasting Output and Inflation: The Role of Asset Prices , 2001 .

[16]  Stephen G. Cecchetti.  Inflation Indicators and Inflation Policy , 1995, NBER Macroeconomics Annual.

[17]  Stephen G. Cecchetti,et al.  The Unreliability of Inflation Indicators , 2000 .

[18]  Lars E. O. Svensson.  Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets , 1996 .

[19]  Jordi Galí,et al.  Monetary Policy in the Early Years of EMU , 2002 .

[20]  Stephen G. Cecchetti,et al.  Measuring Core Inflation , 1993 .

[21]  W. Newey,et al.  A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelationconsistent Covariance Matrix , 1986 .

[22]  Ricardo Mestre,et al.  A Multi-Country Trend Indicator for Euro Area Inflation: Computation and Properties , 2001, SSRN Electronic Journal.

[23]  Mark A. Wynne,et al.  An Evaluation of Some Measures of Core Inflation for the Euro Area , 2001, SSRN Electronic Journal.

[24]  Hervé Le Bihan,et al.  Do core inflation measures help forecast inflation? Out-of-sample evidence from French data , 2000 .

[25]  Anindya Banerjee,et al.  Leading Indicators for Euro-Area Inflation and GDP Growth , 2003 .

[26]  C. Morana,et al.  Core inflation in the Euro area , 2002 .

[27]  Halbert White,et al.  Tests of Conditional Predictive Ability , 2003 .

[28]  J. Stock,et al.  Macroeconomic forecasting in the Euro area: Country specific versus area-wide information , 2003 .

[29]  M. Woodford,et al.  Handbook of Macroeconomics , 1999 .

[30]  Vitor Gaspar,et al.  The Monetary Policy Strategy of the ECB , 1999 .

[31]  J. Galí,et al.  European Inflation Dynamics , 2001 .

[32]  Filippo Altissimo,et al.  Eurocoin: A Real Time Coincident Indicator of the Euro Area Business Cycle , 2001 .

[33]  Marianne Baxter,et al.  Measuring Business Cycles Approximate Band-Pass Filters for Economic Time Series , 1999 .

[34]  Timothy Cogley,et al.  A Simple Adaptive Measure of Core Inflation , 2002 .

[35]  The stability-oriented monetary policy strategy of the Eurosystem , 2007 .

[36]  Inflation Indicators and Inflation Policy , 1995 .

[37]  Donald G. Freeman.  Do core inflation measures help forecast inflation , 1998 .

[38]  Measures of Underlying Inflation in the Euro Area , 2006 .

[39]  The two pillars of the ECB ’ s monetary policy strategy , 2007 .

[40]  Richard A. Davis,et al.  Time Series: Theory and Methods , 2013 .

[41]  C. Folkertsma,et al.  Performance of Core Inflation Measures , 2001 .

[42]  K. West,et al.  Asymptotic Inference about Predictive Ability , 1996 .

[43]  Christopher J. Waller,et al.  From EMS to EMU , 1992 .

[44]  A. Atkeson,et al.  Are Phillips Curves Useful for Forecasting Inflation , 2001 .