P-star in times of crisis - Forecasting inflation for the euro area

In this paper we present three empirically testable versions of the common p-star model and evaluate their forecasting performance using conventional techniques. We try to answer the question if the p-star approach is preferable to achieve a reliable short-run inflation forecast and with regard to the latter we incur the need for a stable demand for money function. Our findings indicate the recurrence of the relevance of the monetary pillar of the ECB's two-pillar framework. In addition, we check for the effects of the current financial and economic crisis that started in 2007 on the forecasting performance, using two sub-sample periods, one excluding and one including the latter, and analyze the impact of the applied filter technique to compute the required equilibrium values.

► We present three empirically testable versions of the common p-star model and show their good performance in forecasting the rate of inflation. ► Our findings indicate the recurrence of the relevance of the monetary pillar of the ECB's two-pillar framework. ► We check for the effects of the current financial and economic crisis that started in 2007 on the forecasting performance using two sub-sample periods. ► We analyze the impact of the applied filter technique to compute the required equilibrium values.