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Does the Phillips curve help to forecast euro area inflation?

Marta Banbura () and Elena Bobeica ()

No 2471, Working Paper Series from European Central Bank

Abstract: We find that it does, but choosing the right specification is not trivial. We unveil notable model instability, with breaks in the performance of most simple Phillips curves. Euro area inflation was particularly hard to forecast in the run-up to the EMU and after the sovereign debt crisis, when the trend and for the latter period, also the amount of slack, were harder to pin down. Yet, some specifications outperform a univariate benchmark most of the time and are thus a useful element in a forecaster's toolkit. We base these conclusions on an extensive forecast evaluation over 1994 - 2018, an extraordinarily long period by euro area standards. We complement the analysis using real-time data over 2005-2018. As lessons for practitioners, we find that: (i) the key type of time variation to consider is an inflation trend; (ii) a simple filter-based output gap works well overall as a measure of economic slack, but after the Great Recession it is outperformed by endogenously estimated slack or by estimates from international economic institutions; (iii) external variables do not bring forecast gains; (iv) newer generation Phillips curve models with several time-varying features are a promising avenue for forecasting, especially when density forecasts are of interest, and finally, (v) averaging over a wide range of modelling choices offers some hedge against breaks in forecast performance. JEL Classification: C53, E31, E37

Keywords: C53; E31; E37 (search for similar items in EconPapers)
Date: 2020-09
New Economics Papers: this item is included in nep-eec, nep-for, nep-his, nep-mac and nep-mon
Note: 810771
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20202471

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