The COVID-19 shock and challenges for inflation modelling.

ABSTRACT: We document the impact of COVID-19 on inflation modelling within a Vector Autoregression (VAR) model and provide guidance for forecasting euro area inflation during the pandemic. We show that estimated parameters are strongly affected, leading to different and sometimes implausible projections. As a solution, we propose to augment the VAR by allowing the residuals to have a fat-tailed distribution instead of a Gaussian one. This also outperforms with respect to unconditional forecasts. Yet, what brings sizeable forecast gains during the pandemic is adding meaningful off-model information, such as that entailed in the Survey of Professional Forecasters. The fat-tailed VAR looses part, but not all of its relative advantage compared to the Gaussian version when producing conditional inflation

SUBMITTER: Bobeica E 

PROVIDER: S-EPMC8761569 | biostudies-literature | 2022 Jan

REPOSITORIES: biostudies-literature