Euro Area Real-Time Density Forecasting with Financial or Labor Market Frictions

101 Pages Posted: 18 Apr 2018

See all articles by Peter McAdam

Peter McAdam

European Central Bank (ECB)

Anders Warne

European Central Bank (ECB)

Date Written: April 06, 2018


We compare real-time density forecasts for the euro area using three DSGE models. The benchmark is the Smets-Wouters model and its forecasts of real GDP growth and inflation are compared with those from two extensions. The first adds financial frictions and expands the observables to include a measure of the external finance premium. The second allows for the extensive labor-market margin and adds the unemployment rate to the observables. The main question we address is if these extensions improve the density forecasts of real GDP and inflation and their joint forecasts up to an eight-quarter horizon. We find that adding financial frictions leads to a deterioration in the forecasts, with the exception of longer-term inflation forecasts and the period around the Great Recession. The labor market extension improves the medium to longer-term real GDP growth and shorter to medium-term inflation forecasts weakly compared with the benchmark model.

Keywords: Bayesian inference, DSGE models, forecast comparison, inflation, output, predictive likelihood

JEL Classification: C11, C32, C52, C53, E37

Suggested Citation

McAdam, Peter and Warne, Anders, Euro Area Real-Time Density Forecasting with Financial or Labor Market Frictions (April 06, 2018). ECB Working Paper No. 2140, ISBN: 978-92-899-3245-5, Available at SSRN: or

Peter McAdam (Contact Author)

European Central Bank (ECB) ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

Anders Warne

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314

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