Francesco Roccazzella

Title: Should we care about ECB inflation expectations?

Abstract:

We use optimal combination of forecasts to introduce a novel forecast encompassing test to evaluate time-series and institutional inflation projections in the euro area. Combination weights reveal which forecasts are the most informative. Although, ECB is the most informative forecaster on average, it does not encompass its competitors and its weight varies over time. Macro-financial conditions and monetary policy actions explain this variability. The greater the uncertainty surrounding inflation and the difference between current and the 2% inflation target, the less informative ECB’s forecasts are. The more contractionary the monetary policy, the more informative they are. ECB’s declining weight and the relation with its determinants raise a warning flag: the potential loss of informativeness damages ECB’s leading role at anchoring inflation expectations and questions whether the goal of preserving financial stability is compatible with the inflation targeting objective.