The name is absent

Roland Dohrn, Christoph M. Schmidt and Tobias Zimmermann*

Inflation Forecasting with Inflation Sentiment Indicators

Abstract

In this paper we argue that future inflation in an economy depends on the way
people perceive current inflation, their inflation sentiment. We construct some
simple measures of inflation sentiment which capture whether price accelera-
tion is shared by many components of the CPI basket. In a comparative analy-
sis of the forecasting power of the different inflation indicators for the US and
Germany, we demonstrate that our inflation sentiment indicators improve
forecast accuracy in comparison to a standard Phillips curve approach. Be-
cause the forecast performance is particularly good for longer horizons, we
also compare our indicators to traditional measures of core inflation. Here, the
sentiment indicators outperform the weighted median and show a similar
forecasting power as a trimmed mean. Thus, they offer a convincing alterna-
tive to traditional core inflation measures.

JEL Classification: E30, E31, E37, C53

Keywords: Inflation forecasting, monetary policy

December 2008

* Roland Dohrn and Tobias Zimmermann, RWI Essen; Christoph M. Schmidt, RWI Essen, Ruhr-
Universitat Bochum, IZA, Bonn, and CEPR, London.-The authors thank Kai Carstensen, Jonas
Dovern and Simeon Vosen for helpful comments to earlier versions of this paper, and Michael
Kind, Claudia Lohkamp and Waltraud Lutze for their technical assistance. We are grateful to
Steve Reed, Rob McClelland and Ken Stewart at the BLS for giving us the opportunity to work
with the CPI research data. - All correspondence to Roland Dohrn, RWI Essen, Hohenzollern-
str. 1-3, 45128 Essen, Germany, e-mail: [email protected].

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