Evaluating Inflation Forecasts in the Euro Area and the Role of the ECB

Abstract

This paper evaluates the informative value of the ECB inflation forecasts vis-à-vis other institutional and model-based forecasts in the euro area using ex post optimal combinations of forecasts and nonnegative weights. From a methodological perspective, we adapt the corresponding forecast encompassing test to the constrained parameter space, showcasing its superior performance over traditional encompassing tests in both size and power properties. Empirically, the combining weights and the forecast encompassing test reveal that the ECB was the most informative forecaster of euro area inflation over the 2009–2021 period. This changed in 2022: The ECB lost its position as the most informative forecaster, and when using rolling windows to estimate the combining weights using a rolling window, we find an important decline in the ECB's weight over time. This time dependency can be associated with the economic environment and, in particular, the level of uncertainty, the monetary policy, and the macro-financial conditions in which the ECB operates.