Forecasting Inflation and Tracking Monetary Policy in the Euro Area: Does National Information Help?

Abstract

The ECB objective is set in terms of year on year growth rate of the Euro area HICP. Nonetheless, a good deal of attention is given to national data by market analysts when they try to anticipate monetary policy moves. In this paper we use the Generalized Dynamic Factor model to develop a set of core inflation indicators that, combining national data with area wide information, allow us to answer two related questions. The first is whether country specific data actually bear any relevance for the future path of area wide price growth, over and above that already contained in area wide data. The second is whether in order to track ECB monetary policy decisions it is useful to take into account national information and not only area wide statistics. In both cases our findings point to the conclusion that, once area wide information is properly taken into account, there is little to be gained from considering national idiosyncratic developments.

Keywords: Forecasting, dynamic factor model, inflation, Taylor rule, monetary policy

JEL Classification: C25, E37, E52