New IMFS Working Paper by Alicia Pita Marcet, Christian Schröder, Maik H. Wolters: Improving Inflation Forecasting by Modeling Expectation De-Anchoring in Low-Inflation Periods
Inflation is often overpredicted during persistent low-inflation periods. We evaluate a model in which inflation expectations can de-anchor, allowing transitions to a low-inflation equilibrium at the effective lower bound. We assess relative and absolute forecast performance using conventional and state-dependent tests. Relative to a model with expectations anchored at the inflation target, the transition model yields substantial accuracy gains during Japan’s prolonged low-inflation episode and for euro area core inflation in the 2010s. These gains do not extend to the United States, where inflation remained closer to target. The absolute forecast evaluation also provides comparatively favorable evidence for the transition model in Japan and for euro area core inflation. Central bank projections are particularly strong at short horizons, reflecting their richer real-time information sets. For euro area core inflation during the low-inflation period, however, the transition model’s forecast errors were roughly 50 percent lower than the ECB’s for the following year and two years ahead.