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Factor forecasts for the UK

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  • Michael Artis
  • Anindya Banerjee
  • Massimiliano Marcellino

Abstract

Time series models are often adopted for forecasting because of their simplicity and good performance. The number of parameters in these models increases quickly with the number of variables modelled, so that usually only univariate or small-scale multivariate models are considered. Yet, data are now readily available for a very large number of macroeconomic variables that are potentially useful when forecasting. Hence, in this paper we construct a large macroeconomic data-set for the UK, with about 80 variables, model it using a dynamic factor model, and compare the resulting forecasts with those from a set of standard time series models. We find that just six factors are sufficient to explain 50% of the variability of all the variables in the data set. Moreover, these factors, which can be considered as the main driving forces of the economy, are related to key variables such as interest rates, monetary aggregates, prices, housing and labour market variables, and stock prices. Finally, the factor-based forecasts are shown to improve upon standard benchmarks for prices, real aggregates, and financial variables, at virtually no additional modelling or computational costs.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 203.

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Handle: RePEc:igi:igierp:203

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  1. Jushan Bai & Serena Ng, 2000. "Determining the Number of Factors in Approximate Factor Models," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 1504, Econometric Society.
  2. Mario Forni & Marc Hallin & Lucrezia Reichlin & Marco Lippi, 2000. "The generalised dynamic factor model: identification and estimation," ULB Institutional Repository 2013/10143, ULB -- Universite Libre de Bruxelles.
  3. James H. Stock & Mark W. Watson, 1988. "A Probability Model of The Coincident Economic Indicators," NBER Working Papers 2772, National Bureau of Economic Research, Inc.
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  5. Michael Artis & Massimiliano Marcellino, 2001. "Fiscal forecasting: The track record of the IMF, OECD and EC," Econometrics Journal, Royal Economic Society, Royal Economic Society, vol. 4(1), pages S20-S36.
  6. Clements, Michael P. & Hendry, David F., 1996. "Multi-Step Estimation for Forecasting," The Warwick Economics Research Paper Series (TWERPS), University of Warwick, Department of Economics 447, University of Warwick, Department of Economics.
  7. James H. Stock & Mark W. Watson, 1998. "Diffusion Indexes," NBER Working Papers 6702, National Bureau of Economic Research, Inc.
  8. Thomas J. Sargent & Christopher A. Sims, 1977. "Business cycle modeling without pretending to have too much a priori economic theory," Working Papers, Federal Reserve Bank of Minneapolis 55, Federal Reserve Bank of Minneapolis.
  9. Clements,Michael & Hendry,David, 1998. "Forecasting Economic Time Series," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521632423.
  10. Marcellino, Massimiliano & Stock, James H. & Watson, Mark W., 2003. "Macroeconomic forecasting in the Euro area: Country specific versus area-wide information," European Economic Review, Elsevier, Elsevier, vol. 47(1), pages 1-18, February.
  11. Michael P. Clements & David F. Hendry, 2001. "Forecasting Non-Stationary Economic Time Series," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262531895, December.
  12. Don Harding & Adrian Pagan, 1999. "Dissecting the Cycle," Melbourne Institute Working Paper Series, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne wp1999n13, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
  13. Marcellino, Massimiliano, 2000. " Forecast Bias and MSFE Encompassing," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, Department of Economics, University of Oxford, vol. 62(4), pages 533-42, September.
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