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Forecasting inflation in the euro area: countries matter!

Author

Listed:
  • Angela Capolongo

    (Université Libre de Bruxelles
    CEPS)

  • Claudia Pacella

    (Université Libre de Bruxelles
    Bank of Italy)

Abstract

We construct a Bayesian vector autoregressive model with three layers of information: the key drivers of inflation, cross-country dynamic interactions, and country-specific variables. The model provides good forecasting accuracy with respect to the popular benchmarks used in the literature. We perform a step-by-step analysis to shed light on which layer of information is more crucial for accurately forecasting medium-run euro area inflation. Our empirical analysis reveals the importance of including the key drivers of inflation and taking into account the multi-country dimension of the euro area. The results show that the complete model performs better overall in forecasting inflation excluding energy and unprocessed food over the medium term. We use the model to establish stylized facts on the euro area and cross-country heterogeneity over the business cycle.

Suggested Citation

  • Angela Capolongo & Claudia Pacella, 2021. "Forecasting inflation in the euro area: countries matter!," Empirical Economics, Springer, vol. 61(5), pages 2477-2499, November.
    • Handle: RePEc:spr:empeco:v:61:y:2021:i:5:d:10.1007_s00181-020-01959-4
    DOI: 10.1007/s00181-020-01959-4
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    More about this item

    Keywords

    Inflation; Forecasting; Bayesian estimation; Multi-country model; Euro area;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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