Do Financial Variables Help Forecasting Inflation and Real Activity in the Euro Area
Università degli studi di Modena e Reggio Emilia (UNIMORE) - Faculty of Business and Economics; Centre for Economic Policy Research (CEPR)
ECARES, Universite Libre de Bruxelles
University of Rome I - Faculty of Statistics - Department of Economic Sciences; Einaudi Institute for Economics and Finance (EIEF)
London Business School; Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES); Centre for Economic Policy Research (CEPR); European Central Bank (ECB)
CEPR Discussion Paper No. 3146
The Paper uses a large data set, consisting of 447 monthly macroeconomic time series concerning the main countries of the Euro area to simulate out-of-sample predictions of the Euro area industrial production and the harmonized inflation index and to evaluate the role of financial variables in forecasting. We considered two models which allow forecasting based on large panels of time series: Forni, Hallin, Lippi, and Reichlin (2000, 2001c) and Stock and Watson (1999). Performance of both models was compared to that of a simple univariate AR model. Results show that multivariate methods outperform univariate methods for forecasting inflation at one, three, six, and twelve months and industrial production at one and three months. We find that financial variables do help forecasting inflation, but do not help forecasting industrial production.
Number of Pages in PDF File: 19
Keywords: Dynamic factor models, principal components, business cycle, forecasting, financial variables
JEL Classification: C13, C33, C43
Date posted: February 7, 2002
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