Forecasting inflation with gradual regime shifts and exogenous information

Arbeitspapier

We propose a new method for medium-term forecasting using exogenous information. We first show how a shifting-mean autoregressive model can be used to describe characteristic features in inflation series. This implies that we decompose the inflation process into a slowly moving nonstationary component and dynamic short-run fluctuations around it. An important feature of our model is that it provides a way of combining the information in the sample and exogenous information about the quantity to be forecast. This makes it possible to form a single model-based inflation forecast that also incorporates the exogenous information. We demonstrate, both theoretically and by simulations, how this is done by using the penalised likelihood for estimating the model parameters. In forecasting inflation, the central bank inflation target, if it exists, is a natural example of such exogenous information. We illustrate the application of our method by an out-of-sample forecasting experiment for euro area and UK inflation. We find that for euro area inflation taking the exogenous information into account improves the forecasting accuracy compared to that of a number of relevant benchmark models but this is not so for the UK. Explanations to these outcomes are discussed.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ECB Working Paper ; No. 1363

Classification and Topics

• Classification: Wirtschaft ; Single Equation Models; Single Variables: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes ; Model Evaluation, Validation, and Selection ; Forecasting Models; Simulation Methods ; Price Level; Inflation; Deflation ; Money and Interest Rates: Forecasting and Simulation: Models and Applications
• Subject: Nonlinear forecast ; nonlinear model ; nonlinear trend ; penalised likelihood ; structural shift ; time-varying parameter

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): González, Andrés ; Hubrich, Kirstin ; Teräsvirta, Timo
• Event: Veröffentlichung
• (who): European Central Bank (ECB)
• (where): Frankfurt a. M.
• (when): 2011

Further information

• Handle: http://hdl.handle.net/10419/153797
• Last update: 10.03.2025, 11:42 AM CET