This assumption postulates that agents form expectations in a forward-looking way, meaning well-anchored inflation expectations are all that is required.3 Broadly speaking, inflation projections invariably show “mean reversion”. This begs the question of how much weight we should give model-based projections, especially in the context of a potential regime shift and rare event.4 Intuitively, more uncertain projections should get less weight.
Looking at the history of Eurosystem/ECB staff inflation projections, errors are small for short horizons, as shown on the right-hand chart. The root-mean-squared error (RMSE) for the one-quarter-ahead projection is 10 basis points. Thus, if inflation is projected at 2% for the next quarter, the two-RMSE confidence interval spans a range running from 1.8% to 2.2%. But errors increase rapidly over the projection horizon.