Firms' inflation expectations enhance real-time core inflation forecasting
A Banco de España working paper finds that models incorporating households' and services firms' inflation expectations significantly improve real-time core inflation forecasting. These qualitative updates serve as relevant signals for aggregate inflation dynamics.
Expectations sharpen inflation forecasts
A Banco de España working paper empirically explores how inflation expectations influence real-time macroeconomic forecasting.
Models incorporating households' updated beliefs about future inflation, and especially services firms' expected price changes, systematically predict core inflation more accurately and stably.
This improved accuracy is observed even in periods of distinct inflation dynamics, such as the euro area's effective lower bound (ELB) period and the post-COVID-19 surge.
The study focuses on euro area core inflation, excluding volatile components, as central banks target medium-term price stabilization.
The findings suggest an economically meaningful pass-through channel of short-term inflation expectations to inflation, reinforcing the New Keynesian Phillips Curve framework.
Unpacking the aggregate price effects
The paper contributes to a growing body of literature examining the causal link between short-run inflation expectations and firm-level pricing.
Previous research highlights the relevance of inflation expectations for household and firm decision-making, with randomized controlled trials showing a pass-through from firms' own expectation updates to their price-setting behavior.
However, a comprehensive empirical exploration of the aggregate price effects of these expectational updates has been lacking.
This study addresses this gap by evaluating the predictive accuracy of inflation models in a real-time fashion, comparing forecasts with and without explicit information on agents' expectations.
A crucial tool for central banks
This study provides robust empirical evidence for the long-debated link between expectations and inflation, offering a practical tool for real-time forecasting.
Its focus on firms' short-term beliefs highlights a key channel for monetary policy transmission.
The findings underscore the ongoing challenge of fully capturing all pass-throughs in complex economic environments.