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Evaluating Factor Models: An Application to Forecasting Inflation in Canada

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  • Marc-André Gosselin
  • Greg Tkacz

Abstract

This paper evaluates the forecasting performance of factor models for Canadian inflation. This type of model was introduced and examined by Stock and Watson (1999a), who have shown that it is quite promising for forecasting U.S. inflation. Using a dimension-reduction method similar to traditional principal-components analysis, we extract a small number of factors from a sample consisting of both Canadian and U.S. data and construct four different factor models. Using parametric and non-parametric tests, we compare the forecasting performance of the factor models to various benchmark forecasting models. We conclude that factor models are as good as more elaborate models in forecasting Canadian inflation. Moreover, we find evidence that a model estimated using only U.S. data is helpful in predicting changes in the Canadian inflation rate.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 01-18.

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Length: 35 pages
Date of creation: 2001
Date of revision:
Handle: RePEc:bca:bocawp:01-18

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Keywords: Inflation and prices; Econometric and statistical methods;

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References

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  1. Ng, S. & Perron, P., 1994. "Unit Root Tests ARMA Models with Data Dependent Methods for the Selection of the Truncation Lag," Cahiers de recherche, Centre interuniversitaire de recherche en économie quantitative, CIREQ 9423, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  2. Jonas D.M. Fisher, 2000. "Forecasting inflation with a lot of data," Chicago Fed Letter, Federal Reserve Bank of Chicago, issue Mar.
  3. Ashley, R & Granger, C W J & Schmalensee, R, 1980. "Advertising and Aggregate Consumption: An Analysis of Causality," Econometrica, Econometric Society, Econometric Society, vol. 48(5), pages 1149-67, July.
  4. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 20(1), pages 134-44, January.
  5. Ben S. Bernanke & Jean Boivin, 2001. "Monetary Policy in a Data-Rich Environment," NBER Working Papers 8379, National Bureau of Economic Research, Inc.
  6. James H. Stock & Mark W. Watson, 1998. "Diffusion Indexes," NBER Working Papers 6702, National Bureau of Economic Research, Inc.
  7. Engert, Walter & Hendry, Scott, 1998. "Forecasting Inflation with the M1-VECM: Part Two," Working Papers, Bank of Canada 98-6, Bank of Canada.
  8. Marc Brisson & Bryan Campbell & John Galbraith, 2001. "Forecasting Some Low-Predictability Time Series Using Diffusion Indices," CIRANO Working Papers, CIRANO 2001s-46, CIRANO.
  9. Tkacz, Greg, 2001. "Neural network forecasting of Canadian GDP growth," International Journal of Forecasting, Elsevier, Elsevier, vol. 17(1), pages 57-69.
  10. Jean-François Fillion & André Léonard, 1997. "La courbe de Phillips au Canada : un examen de quelques hypothèses," Working Papers, Bank of Canada 97-3, Bank of Canada.
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Cited by:
  1. Rangan Gupta & Alan Kabundi & Stephen M. Miller, 2009. "Forecasting the US Real House Price Index: Structural and Non-Structural Models with and without Fundamentals," Working Papers, University of Nevada, Las Vegas , Department of Economics 1001, University of Nevada, Las Vegas , Department of Economics.
  2. Marc-André Gosselin & René Lalonde, 2003. "Un modèle « PAC » d'analyse et de prévision des dépense des ménages américains," Working Papers, Bank of Canada 03-13, Bank of Canada.
  3. Illing, Mark & Liu, Ying, 2006. "Measuring financial stress in a developed country: An application to Canada," Journal of Financial Stability, Elsevier, Elsevier, vol. 2(3), pages 243-265, October.
  4. Eickmeier, Sandra & Ng, Tim, 2011. "Forecasting national activity using lots of international predictors: An application to New Zealand," International Journal of Forecasting, Elsevier, Elsevier, vol. 27(2), pages 496-511, April.
  5. Eliana González & Luis F. Melo & Viviana Monroy & Brayan Rojas, 2009. "A Dynamic Factor Model For The Colombian Inflation," BORRADORES DE ECONOMIA 005273, BANCO DE LA REPÚBLICA.
  6. Mark Illing & Ying Liu, 2003. "An Index of Financial Stress for Canada," Working Papers, Bank of Canada 03-14, Bank of Canada.
  7. Rangan Gupta & Alain Kabundi, 2009. "A Large Factor Model for Forecasting Macroeconomic Variables in South Africa," Working Papers 137, Economic Research Southern Africa.
  8. Lombardi, Marco J. & Maier, Philipp, 2011. "Forecasting economic growth in the euro area during the Great Moderation and the Great Recession," Working Paper Series, European Central Bank 1379, European Central Bank.
  9. Calista Cheung & Frédérick Demers, 2007. "Evaluating Forecasts from Factor Models for Canadian GDP Growth and Core Inflation," Working Papers, Bank of Canada 07-8, Bank of Canada.
  10. Gabriel Moser & Fabio Rumler & Johann Scharler, 2004. "Forecasting Austrian Inflation," Working Papers 91, Oesterreichische Nationalbank (Austrian Central Bank).
  11. Johannes Tang Kristensen, 2012. "Factor-Based Forecasting in the Presence of Outliers: Are Factors Better Selected and Estimated by the Median than by The Mean?," CREATES Research Papers 2012-28, School of Economics and Management, University of Aarhus.

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