Short Term Inflation Forecasting: The M.E.T.A. Approach
48 Pages Posted: 19 Aug 2015
Date Written: June 25, 2015
Forecasting inflation is an important and challenging task. In this paper we assume that the core inflation components evolve as a multivariate local level process. This model, which is theoretically attractive for modelling inflation dynamics, has been used only to a limited extent to date owing to computational complications with the conventional multivariate maximum likelihood estimator, especially when the system is large. We propose the use of a method called “Moments Estimation Through Aggregation” (M.E.T.A.), which reduces computational costs significantly and delivers prompt and accurate parameter estimates, as we show in a Monte Carlo exercise. In an application to euro-area inflation we find that our forecasts compare well with those generated by alternative univariate constant and time-varying parameter models as well as with those of professional forecasters and vector autoregressions.
Keywords: inflation, forecasting, aggregation, state space models
JEL Classification: C32, C53, E31, E37
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