Do inflation expectations improve model-based inflation forecasts?

Those of professional forecasters do. For a wide range of time series models for the euro area and its member states we find a higher average forecast accuracy of models that incorporate information on inflation expectations from the ECB’s SPF and Consensus Economics compared to their counterparts that do not. The gains in forecast accuracy from incorporating inflation expectations are typically not large but statistically significant in some periods. Both short- and long-term expectations provide useful information. The professional forecasters expectations seem to help to correct the upward forecast bias in the low inflation period and to make the model forecasts more robust, in particular in the environment of high volatility. By contrast, incorporating expectations derived from financial market prices or those of firms and households does not lead to systematic improvements in forecast performance. The analysis is undertaken for headline inflation and inflation excluding energy and food and both point and density forecast are evaluated using real-time data vintages over 2001-2022. JEL Classification: C53, E31, E37