Evaluating UK Point and Density Forecasts from an Estimated DSGE Model: The Role of Off-Model Information Over the Financial Crisis

54 Pages Posted: 4 Aug 2015

See all articles by Nicholas Fawcett

Nicholas Fawcett

Bank of England

Lena Korber

Bank of England

Riccardo Masolo

Bank of England

Matthew Waldron

Bank of England

Date Written: July 31, 2015

Abstract

This paper investigates the real-time forecast performance of the Bank of England’s main DSGE model, COMPASS, before, during and after the financial crisis with reference to statistical and judgemental benchmarks. A general finding is that COMPASS’s relative forecast performance improves as the forecast horizon is extended (as does that of the Statistical Suite of forecasting models). The performance of forecasts from all three sources deteriorates substantially following the financial crisis.

The deterioration is particularly marked for the DSGE model’s GDP forecasts. One possible explanation for that, and a key difference between DSGE models and judgemental forecasts, is that judgemental forecasts are implicitly conditioned on a broader information set, including faster-moving indicators that may be particularly informative when the state of the economy is evolving rapidly, as in periods of financial distress. Consistent with that interpretation, GDP forecasts from a version of the DSGE model augmented to include a survey measure of short-term GDP growth expectations are competitive with the judgemental forecasts at all horizons in the post-crisis period. More generally, a key theme of the paper is that both the type of off-model information and the method used to apply it are key determinants of DSGE model forecast accuracy.

Keywords: DSGE models, forecasting, financial crisis

JEL Classification: C53, E12, E17.

Suggested Citation

Fawcett, Nicholas and Korber, Lena and Masolo, Riccardo and Waldron, Matthew, Evaluating UK Point and Density Forecasts from an Estimated DSGE Model: The Role of Off-Model Information Over the Financial Crisis (July 31, 2015). Bank of England Working Paper No. 538, Available at SSRN: https://ssrn.com/abstract=2639055 or http://dx.doi.org/10.2139/ssrn.2639055

Nicholas Fawcett (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Lena Korber

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Riccardo Masolo

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Matthew Waldron

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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