Trade consistency in the context of the Eurosystem projection exercises – an overview

The Eurosystem macroeconomic projection exercises are part of the input prepared for the Governing Council’s decision-making meetings. Under the economic analysis pillar of the ECB’s monetary policy strategy, they are a key element in the assessment of economic prospects and of the short to medium-term risks to price stability. The projection exercises are conducted on the basis of a number of “technical” assumptions. In particular, assumptions are made about future developments in world trade, foreign prices and nominal exchange rates. The purpose of the trade consistency exercise (TCE) is to ensure that individual country forecasts are consistent with each other regarding the assumptions made about the international environment. Trade consistency is ensured in two directions: first, the cross-trade consistency part of the TCE involves examining the consistency of the trade projections at any given point in time; and second, the ex ante/ex post trade consistency part involves comparing the projections for a given variable across different projection rounds. This paper provides a comprehensive description of the data and techniques underlying the trade consistency exercises in the context of the projection exercises of the Eurosystem and the ECB. JEL Classification: C23, D92, E22, E52, G31, G32competitiveness, cross-country consistency, market shares, Trade projections

Assessing the sensitivity of inflation to economic activity

A number of academic studies suggest that from the mid-1990s onwards there were changes in the link between inflation and economic activity. However, it remains unclear the extent to which this phenomenon can be ascribed to a change in the structural relationship between inflation and output, as opposed to a change in the size and nature of the shocks hitting the economy. This paper uses a suite of models, such as time-varying VAR techniques, traditional macro models, as well as DSGE models, to investigate, for various European countries as well as for the euro area, the evolution of the link between inflation and resource utilization and its dependence on the nature and size of the shocks. Our analysis suggests that the relationship between inflation and activity has indeed been changing over time, while remaining positive, with the correlation peaking during recessions. Quantitatively, the link between output and inflation is found to be highly dependent on which type of shocks hit the economy: while, in general, all demand shocks to output imply a reaction of inflation of the same sign, the latter will be less pronounced when output fluctuations are driven by supply shocks. In addition, a sharp deceleration of activity, as opposed to a subdued but protracted slowdown, results in a swifter decline in inflation. Inflation exhibits a rather strong persistence, with a negative impact still visible three years after the initial shock. JEL Classification: E31, E32, E37demand shock, inflation response, Macro model, output growth, Phillips curve