Forecasting Euro Area Inflation Using Dynamic Factor Measures of Underlying Inflation

34 Pages Posted: 13 Dec 2004

Date Written: November 2004

Abstract

Standard measures of prices are often contaminated by transitory shocks. This has prompted economists to suggest the use of measures of underlying inflation to formulate monetary policy and assist in forecasting observed inflation. Recent work has concentrated on modelling large datasets using factor models. In this paper we estimate factors from datasets of disaggregated price indices for European countries. We then assess the forecasting ability of these factor estimates against other measures of underlying inflation built from more traditional methods. The power to forecast headline inflation over horizons of 12 to 18 months is adopted as a valid criterion to assess forecasting. Empirical results for the five largest euro area countries as well as for the euro area are presented.

Keywords: Core Inflation, Dynamic Factor Models, Forecasting

JEL Classification: E31, C13, C32

Suggested Citation

Camba-Mendez, Gonzalo and Kapetanios, George, Forecasting Euro Area Inflation Using Dynamic Factor Measures of Underlying Inflation (November 2004). Available at SSRN: https://ssrn.com/abstract=601022

Gonzalo Camba-Mendez (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

George Kapetanios

King's College, London ( email )

30 Aldwych
London, WC2B 4BG
United Kingdom
+44 20 78484951 (Phone)

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