Is euro area lowflation here to stay? Insights from a time-varying parameter model with survey data

We build a time-varying parameter model that jointly explains the dynamics of euro area inflation and inflation expectations. Our goal is to explain the weak inflation during the post-financial crisis economic recovery of 2013-2019. We find that the inclusion of survey data leads to a more muted decline of trend inflation in recent years and more economic slack. Moreover, the impact of economic slack and import prices on inflation has recently strengthened, and survey respondents updated their beliefs more actively over the financial crisis period. Our model compares well against restricted specifications in terms of forecast performance and marginal likelihood.