Abstract
Understanding inflationary pressures across euro area member states is critical for European Central Bank (ECB) policymakers to implement effective fiscal and monetary strategies. To support this, considerable research has focused on developing inflationary pressure indicators. However, many of these indicators rely on dynamic factor models that treat observations at each time point as a vector, overlooking the potential structure in the data.
When variables are organized into a well-defined matrix over time, stacking them into a vector can lead to a loss of important structural information. This research seeks to develop an inflationary pressure indicator using a matrix dynamic factor model (MDFM), which preserves the matrix structure and provides a more comprehensive assessment of inflationary pressures across the euro area.
By maintaining the matrix format, the MDFM captures both within-dimension comovements and interactions between dimensions. Moreover, the model can handle missing data, allowing for the estimation of inflationary pressure indicators for more countries and utilizing a broader range of series, even when some data are incomplete.