Economic Theory and Forecasting: Lessons from the Literature

35 Pages Posted: 14 Oct 2014

See all articles by Raffaella Giacomini

Raffaella Giacomini

University College London - Department of Economics; University of California, Los Angeles - Department of Economics

Date Written: October 2014

Abstract

Does economic theory help in forecasting key macroeconomic variables? This article aims to provide some insight into the question by drawing lessons from the literature. The definition of "economic theory" includes a broad range of examples, such as accounting identities, disaggregation and spatial restrictions when forecasting aggregate variables, cointegration and forecasting with Dynamic Stochastic General Equilibrium (DSGE) models. We group the lessons into three themes. The first discusses the importance of using the correct econometric tools when answering the question. The second presents examples of theory-based forecasting that have not proven useful, such as theory-driven variable selection and some popular DSGE models. The third set of lessons discusses types of theoretical restrictions that have shown some usefulness in forecasting, such as accounting identities, disaggregation and spatial restrictions, and cointegrating relationships. We conclude by suggesting that economic theory might help in overcoming the widespread instability that affects the forecasting performance of econometric models by guiding the search for stable relationships that could be usefully exploited for forecasting.

Keywords: Bayesian methods, DSGE models, exponential tilting

JEL Classification: C52, C53

Suggested Citation

Giacomini, Raffaella, Economic Theory and Forecasting: Lessons from the Literature (October 2014). CEPR Discussion Paper No. DP10201, Available at SSRN: https://ssrn.com/abstract=2510059

Raffaella Giacomini (Contact Author)

University College London - Department of Economics ( email )

Gower Street
London WC1E 6BT, WC1E 6BT
United Kingdom

University of California, Los Angeles - Department of Economics ( email )

405 Hilgard Avenue
Box 951361
Los Angeles, CA 90095-1361
United States

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