Data dependency, inflation projections and interest rate decisions

Vincenzo Cuciniello, Giuseppe Ferrero (), Elisa Guglielminetti () and Alessandro Lin ()
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Giuseppe Ferrero: Bank of Italy
Elisa Guglielminetti: Bank of Italy
Alessandro Lin: Bank of Italy

No 930, Questioni di Economia e Finanza (Occasional Papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: In 2023, the ECB introduced three criteria – inflation outlook, underlying inflation dynamics, and monetary policy transmission – to guide its data-dependent approach to policy rates. We argue that this shift does not imply a change in the ECB's reaction function to deviations of medium-term inflation from target but rather reflects the use of alternative signals to assess medium-term inflation, a variable that is not directly observable. By integrating multiple indicators, the ECB aimed to enhance its inflation assessment, improving policy decisions in an environment of increased uncertainty. During the 2021-22 inflation surge, forecasts incorporating underlying inflation and monetary policy transmission outperformed staff projections over a one-year horizon. However, in the subsequent disinflation phase, these forecasts overestimated inflation and underperformed relative to staff projections, raising concerns about an overly restrictive monetary policy stance. Our results underscore the importance of placing greater emphasis on medium-term projections when their accuracy is in line with historical regularities.

Keywords: data dependence; reaction function; underlying inflation; monetary policy transmission (search for similar items in EconPapers)
JEL-codes: E43 E47 E52 E58 (search for similar items in EconPapers)
Date: 2025-04
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