European Commission Directorate General Economic and Financial Affairs The forecasting horizon of inflationary expectations and perceptions in the EU – Is it real 12 months? Presentation by Staffan Lindén Directorate of Economic Studies and Research Third Joint EC-OECD Workshop on International Developments of BCTS 12 November 2007, Brussels European Commission 2007

Purpose To examine the forecast horizon used by respondents to consumer surveys Inflation expectations, forecasts Inflation perceptions, backcasts Respondents are asked about a forecast for 12 months ahead For which horizon respondents actually give the best forecast, is an open question European Commission 2007

Data – Survey questions Data come from the Joint Harmonised Programme of Consumer Surveys Quantitative price questions By how many percent do you expect consumer prices to go up/down in the next 12 months? By how many percent do you think that consumer prices have gone up/down over the past 12 months? European Commission 2007

Data – Aggregates Perceived and expected inflation Monthly averages for 18 countries 12 countries from the euro area Answers higher than +95% or lower than -95% are truncated to +/-95% Monthly HICP inflation rates are used as reference series European Commission 2007

Methodology I We examine the forecast errors at different leads and lags Mean error Root mean square error European Commission 2007

Stylised illustration of expected results European Commission 2007

Methodology II 25 month lead-lag window Expectation: 0 to +24 months Perceptions: -12 to +12 European Commission 2007

Findings – Expectations, U-shapes European Commission 2007

Findings – Expectations European Commission 2007

Summary Findings – Expectations 8 countries with U-shapes within in the 0 to +24 month window Average forecast horizon is 13 months Another 5 if the lead-lag window is shifted The forecasts improve by 0.6 of a percentage point The countries inflation history is not an explaining factor European Commission 2007

Findings – Perceptions, U-shapes European Commission 2007

Findings – Perceptions European Commission 2007

Findings – Perceptions European Commission 2007

Summary Findings – Perceptions 4 countries with U-shapes within in the -12 to +12 month window Average forecast horizon is 13 months Another 8 if the lead-lag window is shifted The forecasts improve by 0.6-0.5 of a percentage point The countries inflation history is not relevant European Commission 2007

Concluding remarks This is preliminary work that needs to be refined Include all available countries Include other measures e.g. correlations Tests Concerns: the euro changeover Suggestions are welcome European Commission 2007