Noah Clason: Forecasting Euro Area Inflation By Aggregating Sub-components

The aim of this paper is to see whether one can improve on the naive forecast of Euro Area inflation, where by naive forecast we mean the year-over-year inflation rate one-year ahead will be the same as the past year. Various model selection procedures are employed on an autoregressive-moving-average model and several Phillips curve based models. We test also whether we can improve on the Euro Area inflation forecast by first forecasting the sub-components and aggregating them. We manage to substantially improve on the forecast by using a Phillips curve based model. We also find further improvement by forecasting the sub-components first and aggregating them to Euro Area inflation.