ECB staff, for example, have developed an indicator, based on a large set of economic variables, that outperforms other measures in its ability to forecast underlying inflation out of sample. Clearly, this measure would point to continued substantial slack in the euro area economy. But such indicators come with two caveats.
The first is that they “reverse engineer” – that is, inflation, or the lack thereof, is always and everywhere attributed to economic slack. And the second caveat is that they are difficult to reconcile with both survey-based and hard data-based indicators of slack in the labour market, which even point to growing signs of labour shortages.