Is euro area lowflation here to stay? Insights from a time-varying parameter model with survey data
Working Paper N° 355
Inﬂation has been persistently weak in the euro area despite the economic recovery since 2013. We investigate the sources behind this protracted low inﬂation by building a time-varying parameter model that jointly explains the dynamics of inﬂation and inﬂation expectations from the ECB’s Survey of Professional Forecasters. We ﬁnd that the inclusion of survey data strengthens the view that low inﬂation was mainly due to cyclical drivers. In particular, the model with survey expectations ﬁnds a more muted decline of trend inﬂation in recent years and a larger degree of economic slack. The impact of economic slack and import prices on inﬂation is found to have increased in recent years. We also ﬁnd that survey expectations have become less persistent over the ﬁnancial crisis period, and that including survey data improves the model’s out-of-sample forecasting performance.