nep-for New Economics Papers
on Forecasting
Issue of 2007‒03‒31
fifteen papers chosen by
Rob J Hyndman
Monash University

  1. An Analysis of Tax Revenue Forecast Errors By Martin Keene; Peter Thomson
  2. Mismeasured personal saving and the permanent income hypothesis By Leonard I. Nakamura; Tom Stark
  3. Term Structure Forecasting: No-Arbitrage Restrictions vs Large Information Set By Favero, Carlo A; Niu, Linlin; Sala, Luca
  4. The Taylor rule and interest rate uncertainty in the U.S. 1955-2006 By Mandler, Martin
  5. Explaining the US Bond Yield Conundrum By Bandholz, Harm; Clostermann, Joerg; Seitz, Franz
  6. Inflation forecasts, monetary policy and unemployment dynamics: evidence from the US and the euro area. By Matteo Ciccarelli; Carlo Altavilla
  7. Shocks and frictions in US business cycles: a Bayesian DSGE approach. By Frank Smets; Rafael Wouters
  8. Are survey-based inflation expectations in the euro area informative. By Ricardo Mestre
  9. Predicting sharp depreciations in industrial country exchange rates By Jonathan H. Wright; Joseph E. Gagnon
  10. A model of near-rational exuberance By James B. Bullard; George W. Evans; Seppo Honkapohja
  11. Monetary policy, judgment and near-rational exuberance By James B. Bullard; George W. Evans; Seppo Honkapohja
  12. Realized Correlation Tick-by-Tick By Fulvio Corsi; Francesco Audrino
  13. When Supply Meets Demand: The Case of Hourly Spot Electricity Prices By Alexander Boogert; Dominique Dupont
  14. Forecasting and Evaluating Network Growth By Norah Montes de Oca; Feng Xie; David Levinson
  15. Identifying asymmetry in the language of the beige book: a mixed data sampling approach By Michelle T. Armesto; Rubén Hernández-Murillo; Michael T. Owyang; Jeremy M. Piger

  1. By: Martin Keene; Peter Thomson (New Zealand Treasury)
    Abstract: The New Zealand Treasury forecasts tax revenue for the twice-yearly Economic and Fiscal Updates. The accuracy of these forecasts is important for the government's annual budget decisions as they affect key fiscal aggregates such as the operating balance and debt levels. Good decision-making in this area is important for macroeconomic stability and sustainability, one of the Treasury's outcomes. Over the past six years, Treasury tax forecasts, and the macroeconomic forecasts on which they are based, have underestimated the actual outturns. This report presents an analysis of the Treasury's tax revenue forecast errors, both in aggregate and disaggregated by individual tax type. The analysis focuses primarily on the annual one-year-ahead Budget forecasts that are typically based on rating up past tax revenues by growth rates in related macroeconomic variables such as GDP. The objective of the analysis is to better determine the major sources of tax revenue forecast error and to identify the potential for methodological improvements. A review of the Treasury’s tax forecasting methods is given and a general class of models proposed that encompasses these methods. Adopting one of the simplest of these as a benchmark, the individual tax revenue forecast errors are first disaggregated into component errors due to forecasting the macroeconomic drivers used as a proxy for the tax base, and a component due to forecasting the tax ratio, or ratio of tax revenue to proxy tax base. The tax ratio is further disaggregated into a component error due to forecasting the tax ratio trend and random error. The latter provides a measure of the best accuracy that can be achieved using the benchmark models adopted. Among other findings, the report shows that the main source of tax revenue underforecasting is the underforecasting of the macroeconomic variables used as taxbase proxies. The tax ratio forecasts were generally unbiased, but less precisely determined than the macroeconomic forecasts. This and other evidence indicate that better tax ratio forecasts are likely to be achieved, even with the simple benchmark model used here. The benchmark models have merit as competing models that could be investigated further alongside other simple structural time series models in a systematic evaluation using historical data.
    Keywords: Tax revenue forecasting; forecast error decompositions; disaggregation; benchmark models
    JEL: C53 E17 H68
    Date: 2007–03
  2. By: Leonard I. Nakamura; Tom Stark
    Abstract: Is it possible to forecast using poorly measured data? According to the permanent income hypothesis, a low personal saving rate should predict rising future income (Campbell, 1987). However, the U.S. personal saving rate is initially poorly measured and has been repeatedly revised upward in benchmark revisions. The authors use both conventional and real-time estimates of the personal saving rate in vector autoregressions to forecast real disposable income; using the level of the personal saving rate in real time would have almost invariably made forecasts worse, but first differences of the personal saving rate are predictive. They also test the lay hypothesis that a low personal saving rate has implications for consumption growth and find no evidence of forecasting ability.
    Date: 2007
  3. By: Favero, Carlo A; Niu, Linlin; Sala, Luca
    Abstract: This paper addresses the issue of forecasting the term structure. We provide a unified state-space modelling framework that encompasses different existing discrete-time yield curve models. Within such framework we analyze the impact on forecasting performance of two crucial modelling choices, i.e. the imposition of no-arbitrage restrictions and the size of the information set used to extract factors. Using US yield curve data, we find that: a. macro factors are very useful in forecasting at medium/long forecasting horizon; b. financial factors are useful in short run forecasting; c. no-arbitrage models are effective in shrinking the dimensionality of the parameter space and, when supplemented with additional macro information, are very effective in forecasting; d. within no-arbitrage models, assuming time-varying risk price is more favourable than assuming constant risk price for medium horizon-maturity forecast when yield factors dominate the information set, and for short horizon and long maturity forecast when macro factors dominate the information set; e. however, given the complexity and the highly non-linear parameterization of no-arbitrage models, it is very difficult to exploit within this type of models the additional information offered by large macroeconomic datasets.
    Keywords: factor models; forecasting; large data set; term structure of interest rates; Yield curve
    JEL: C33 C53 E43 E44
    Date: 2007–03
  4. By: Mandler, Martin
    Abstract: We use a Taylor rule with time-varying policy coefficients in combination with an unobserved components model for the output gap to estimate the uncertainty about future values of the Federal Funds Rate. The model makes it possible to separate ex-ante interest rate uncertainty into three components: 1) uncertainty about the Fed's future policy coefficients, 2) uncertainty about future economic fundamentals, and 3) residual uncertainty. The results show important changes in uncertainty about future short-term interest rates over time with peaks in the late 1960s/early 1970s, mid 1970s and late 1970s/early 1980s. While for one-quarter forecasts uncertainty about the Fed's policy reaction is more important than uncertainty about economic fundamentals this result is reversed for the two-quarter forecast horizon. Results from a modified model with regime shifts in the variance of the policy shocks confirm the previous findings but show changes in residual uncertainty to be important as well.
    Keywords: monetary policy rules; interest rate uncertainty; Kalman filter
    JEL: C53 C32 E52
    Date: 2007–03
  5. By: Bandholz, Harm; Clostermann, Joerg; Seitz, Franz
    Abstract: We analyze if and to what extent fundamental macroeconomic factors, temporary influences or more structural factors have contributed to the low levels of US bond yields over the last few years. For that purpose, we start with a general model of interest rate determination. The empirical part consists of a cointegration analysis with an error correction mechanism. We are able to establish a stable long-run relationship and find that the behavior of bond yields, even during the last two years, can well be explained. Alongside the more traditional macroeconomic determinants like core inflation, monetary policy and the business cycle, we also include foreign holdings of US Treasuries. The latter should capture the frequently mentioned structural effects on long-term interest rates. Finally, our bond yield equation outperforms a random walk model in different forecasting exercises.
    Keywords: bond yields; interest rates; cointegration; inflation; forecasting
    JEL: E47 E43
    Date: 2007–02
  6. By: Matteo Ciccarelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Carlo Altavilla (University of Naples "Parthenope", Via Medina 40, 80133 Naples, Italy.)
    Abstract: This paper explores the role that inflation forecasts play in the uncertainty surrounding the estimated effects of alternative monetary rules on unemployment dynamics in the euro area and the US. We use the inflation forecasts of 8 competing models in a standard Bayesian VAR to analyse the size and the timing of these effects, as well as to quantify the uncertainty relative to the different inflation models under two rules. The results suggest that model uncertainty can be a serious issue and strengthen the case for a policy strategy that takes into account several sources of information. We find that combining inflation forecasts from many models not only yields more accurate forecasts than those of any specific model, but also reduces the uncertainty associated with the real effects of policy decisions. These results are in line with the model-combination approach that central banks already follow when conceiving their strategy. JEL Classification: C53; E24; E37.
    Keywords: Inflation forecasts; unemployment; model uncertainty.
    Date: 2007–02
  7. By: Frank Smets (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Rafael Wouters (National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.)
    Abstract: Using a Bayesian likelihood approach, we estimate a dynamic stochastic general equilibrium model for the US economy using seven macro-economic time series. The model incorporates many types of real and nominal frictions and seven types of structural shocks. We show that this model is able to compete with Bayesian Vector Autoregression models in out-of-sample prediction. We investigate the relative empirical importance of the various frictions. Finally, using the estimated model we address a number of key issues in business cycle analysis: What are the sources of business cycle fluctuations? Can the model explain the cross-correlation between output and inflation? What are the effects of productivity on hours worked? What are the sources of the “Great Moderation”? JEL Classification: E4-E5.
    Keywords: Keywords: DSGE models; monetary policy
    Date: 2007–02
  8. By: Ricardo Mestre (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper contributes to the old theme of testing for rationality of inflation expectations in surveys, using two very different surveys in parallel. Focusing on the euro area and using two well-known surveys that include questions on inflation expectations, the Consensus Forecast survey and the European Commission Household survey, a battery of tests is applied to inflation forecasts. Tests are based on a preliminary discussion of the meaning of Rational Expectations in the macroeconomic literature, and how this maps into specific econometric tests. Tests used are both standard ones already reported in the literature and less standard ones of potential interest within the framework discussed. Tests focus on in-sample properties of the forecasts, both in static and dynamic settings, and in out-of sample tests to explore the performance of the forecasts in a simulated out-of-sample setting. As a general conclusion, both surveys are found to contain potentially useful information. Although the Consensus Forecasts survey is the best one in terms of quality of the forecasts, rationality in the European Commission Household survey, once measurement issues are taken into account, cannot be ruled out. JEL Classification:C40; C42; C50; C53; E37.
    Keywords: Rational expectations; tests of rationality; inflation forecasting.
    Date: 2007–02
  9. By: Jonathan H. Wright; Joseph E. Gagnon
    Abstract: This paper considers the prediction of large depreciations (both nominal and real) in a panel of industrialized countries using a probit methodology. The current account balance/GDP ratio has a modest but statistically significant effect on the estimated probability of a large depreciation, and gives slight predictive power in an out-of-sample forecasting exercise. The CPI inflation rate also has a modest but statistically significant effect in predicting nominal depreciations and has slight predictive power, but this effect is not present for real exchange rates. The GDP growth rate occasionally has a significant effect. A higher current account balance (surplus) tends to reduce the probability of a sharp depreciation; a higher inflation rate tends to increase the probability of a sharp depreciation; and a higher GDP growth rate perhaps tends to reduce the probability of a sharp depreciation.
    Keywords: Foreign exchange rates ; Econometric models
    Date: 2006
  10. By: James B. Bullard; George W. Evans; Seppo Honkapohja
    Abstract: We study how the use of judgment or "add-factors" in forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We isolate conditions under which new phenomena, which we call exuberance equilibria, can exist in a standard self-referential environment. Local indeterminacy is not a requirement for existence. We construct a simple asset pricing example and find that exuberance equilibria, when they exist, can be extremely volatile relative to fundamental equilibria.
    Keywords: Monetary policy ; Rational expectations (Economic theory)
    Date: 2007
  11. By: James B. Bullard; George W. Evans; Seppo Honkapohja
    Abstract: We study how the use of judgment or "add-factors" in macroeconomic forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We examine the possibility of a new phenomenon, which we call exuberance equilibria, in the New Keynesian monetary policy framework. Inclusion of judgment in forecasts can lead to self-fulfilling fluctuations in a subset of the determinacy region. We study how policymakers can minimize the risk of exuberance equilibria.
    Keywords: Rational expectations (Economic theory) ; Monetary policy
    Date: 2007
  12. By: Fulvio Corsi; Francesco Audrino
    Abstract: We propose the Heterogeneous Autoregressive (HAR) model for the estimation and prediction of realized correlations. We construct a realized correlation measure where both the volatilities and the covariances are computed from tick-by-tick data. As for the realized volatility, the presence of market microstructure can induce significant bias in standard realized covariance measure computed with artificially regularly spaced returns. Contrary to these standard approaches we analyse a simple and unbiased realized covariance estimator that does not resort to the construction of a regular grid, but directly and efficiently employs the raw tick-by-tick returns of the two series. Montecarlo simulations calibrated on realistic market microstructure conditions show that this simple tick-by-tick covariance possesses no bias and the smallest dispersion among the covariance estimators considered in the study. In an empirical analysis on S&P 500 and US bond data we find that realized correlations show significant regime changes in reaction to financial crises. Such regimes must be taken into account to get reliable estimates and forecasts.
    Keywords: High frequency data, Realized Correlation, Market Microstructure, Bias correction, HAR, Regimes
    JEL: C13 C22 C51 C53
    Date: 2007–01
  13. By: Alexander Boogert (School of Economics, Mathematics & Statistics, Birkbeck); Dominique Dupont
    Abstract: We use a supply-demand framework to model the hourly day-ahead spot price of electricity based on publicly available information. With the model we can forecast the level and the probability of a spike in the spot price de¯ned as the spot price being above a certain threshold. Several European countries have recently started publishing day-ahead forecasts of the available supply. In this paper we show potential uses of such indicators and test their forecasting power in an hourly spot price model. We conclude that a forecast of the available supply can be part of a useful indicator and discuss ways to further improve the forecasts.
    Date: 2007–03
  14. By: Norah Montes de Oca; Feng Xie; David Levinson (Nexus (Networks, Economics, and Urban Systems) Research Group, Department of Civil Engineering, University of Minnesota)
    Abstract: This research assesses the implications of existing trends on future network investment, comparing alternative scenarios concerning budgets and investment rules across a variety of performance measures. The main scenarios compare 'stated decision rules';, processes encoded in flowcharts and weights developed from official documents or by discussion with agency staff, with 'revealed decision rules', weights estimated statistically based on observed historical behavior. This research specifies the processes necessary to run the network forecasting models with various decision rules. Results for different scenarios are presented including adding additional constraints for the transportation network expansion and calibration process details. We find that alternative decision rules make only small differences in overall system performance, though they direct investments to very different locations. However, changes in total budget can make a significant difference to system-wide performance.
    JEL: R41 R42 R48
    Date: 2006
  15. By: Michelle T. Armesto; Rubén Hernández-Murillo; Michael T. Owyang; Jeremy M. Piger
    Abstract: Studies of the predictive ability of the Federal Reserve's Beige Book, an anecdotal measure of regional economic conditions, for aggregate output and employment have proven inconclusive. This might be attributed, in part, to the irregular release schedule of the Beige Book. In this paper, we use a model that allows for data sampling at mixed frequencies to analyze the predictive power of the Beige Book for both aggregate and regional data. We find that the Beige Book's national summary predicts GDP and aggregate employment, but that the information content in the district reports for regional employment is mixed. In addition, there appears to be an asymmetry in the predictive content of the Beige Book language. At the national level, pessimistic language in the national summary reflects the underlying business cycle phase, while optimistic language is informative for higher frequency fluctuations. At the district level, the reverse is true; pessimistic language reflects sharp, temporary economic fluctuations.
    Keywords: Economic conditions - United States ; Federal Open Market Committee ; Federal Reserve System ; Business forecasting
    Date: 2007

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