Working Paper: CEPR ID: DP3097
Authors: Riccardo Cristadoro; Mario Forni; Lucrezia Reichlin; Giovanni Veronese
Abstract: This Paper proposes an index of core inflation for the euro area which exploits information from a large panel of time series on disaggregated prices, industrial production, labour market indicators, financial and monetary variables. The index is the result of a smoothing operation at both the cross-sectional and time series level. By extracting the common component of national inflation and disregarding the idiosyncratic one, we clean inflation from measurement error, discrepancies in data recording and dynamics originated by national or sectoral idiosyncratic shocks (cross-sectional smoothing). By extracting the component with periodicity longer than one year we clean from high frequency variation and seasonal components which are not relevant for monetary policy (time series smoothing). The indicator is shown to have a number of desirable characteristics and to perform very well as a forecaster of the euro area harmonized consumer price index at one and two years horizon, which is the relevant horizon for the ECB monetary policy.
Keywords: core inflation; dynamic factor model; inflation forecast; monetary policy
JEL Codes: E31; C32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| core inflation index (E31) | future inflation rates (E31) |
| core inflation index (E31) | euro area inflation (E31) |
| core inflation index (E31) | harmonized consumer price index (HICP) (C43) |
| core inflation index (E31) | forecasting accuracy (C53) |
| traditional measures (C52) | high-frequency noise (C58) |