Impact of uncertainty on inflation forecast errors in Central and Eastern European countries

Abstract

AbstractThe question underlying the research problem addressed by this study concerns various factors, including uncertainty, that could affect forecast errors. Previous works, focusing mainly on world-leading economies, are inconclusive on how economic agents form inflation forecasts or why forecast errors occur. There is a gap in the empirical literature that needs to be filled. The analysis covers the 2016–2020 period and seven economies: Albania, Czechia, Hungary, Poland, Romania, Serbia, and Turkey. We verify whether forecast errors are driven by production, inflation, exchange rates, interest rates, oil prices, changes in the tone of the central bank’s releases and their uncertainty. We assess whether economic agents can process available information to present accurate inflation forecasts. The results suggest that neither consumers nor professionals do—they present inaccurate forecasts regularly. The results suggest that exchange rate volatility is the most important variable that positively affects forecast errors, followed by inflation and its volatility. This confirms (in most cases) a theoretical assumption that a stable environment is better for long-term development as lower inflation forecast errors allow for the optimization of economic decisions. The study implies that mechanisms supporting forecasting during turbulent times must be strengthened. It presents the set of variables that should be analyzed more carefully by consumers and professionals. In addition, central banks could provide more precise communication regarding the evolution of error drivers. Our results build on existing literature by explicitly linking macroeconomic uncertainty with forecast errors including for small open economies from Eurasia.