Can inﬂation expectations in business or consumer surveys improve inﬂation forecasts?
Working Paper N° 348
In this paper we develop a new model that incorporates inﬂation expectations and can be used for the structural analysis of inﬂation, as well as for forecasting. In this latter connection, we speciﬁcally look into the usefulness of real-time survey data for inﬂation projections. We contribute to the literature in two ways. First, our model extracts the inﬂation trend and its cycle, which is linked to real economic activity, by exploiting a much larger information set than typically seen in this class of models and without the need to resort to Bayesian techniques. The reason is that we use variables reﬂecting inﬂation expectations from consumers and ﬁrms under the assumption that they are consistent with the expectations derived from the model. Thus, our approach represents an alternative way to shrink the model parameters and to restrict the future evolution of the factors. Second, the inﬂation expectations that we use are derived from the qualitative questions on expected price developments in both the consumer and the business surveys. This latter source, in particular, is mostly neglected in the empirical literature. Our empirical results suggest that overall, inﬂation expectations in surveys provide useful information for inﬂation forecasts. In particular for the most recent period, models that include survey expectations on prices tend to outperform similar models that do not, both for Belgium and the euro area. Furthermore, we ﬁnd that the business survey, i.e. the survey replies by the price-setters themselves, contributes most to these forecast improvements.