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Forecasting euro area inflation using dynamic factor measures of underlying inflation
Author(s) -
CambaMendez Gonzalo,
Kapetanios George
Publication year - 2005
Publication title -
journal of forecasting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.543
H-Index - 59
eISSN - 1099-131X
pISSN - 0277-6693
DOI - 10.1002/for.964
Subject(s) - inflation (cosmology) , economics , dynamic factor , econometrics , monetary policy , inflation targeting , headline , macroeconomics , linguistics , philosophy , physics , theoretical physics
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 data sets using factor models. In this paper we estimate factors from data sets 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 itself, are presented. Copyright © 2005 John Wiley & Sons, Ltd.