Forecasting Inflation With a Random Walk
The use of different time-series models to generate forecasts is fairly usual in the forecasting literature in general, and in the inflation forecast literature in particular. When the predicted variable is stationary, the use of processes with unit roots may seem counterintuitive. Nevertheless, in this paper we demonstrate that forecasting a stationary variable with driftless unit-root-based forecasts generates bounded Mean Squared Prediction Errors errors at every single horizon. We also show via simulations that persistent stationary processes may be better predicted by unit-root-based forecasts than by forecasts coming from a model that is correctly specified but that is subject to a higher degree of parameter uncertainty. Finally we provide an empirical illustration in the context of CPI inflation forecasts for three industrialized countries.
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- Clark, Todd E. & West, Kenneth D., 2006.
"Using out-of-sample mean squared prediction errors to test the martingale difference hypothesis,"
Journal of Econometrics,
Elsevier, vol. 135(1-2), pages 155-186.
- Todd E. Clark & Kenneth D. West, 2004. "Using out-of-sample mean squared prediction errors to test the Martingale difference hypothesis," Research Working Paper RWP 04-03, Federal Reserve Bank of Kansas City.
- Graham Elliott & Allan Timmermann, 2008.
Journal of Economic Literature,
American Economic Association, vol. 46(1), pages 3-56, March.
- Todd E. Clark & Kenneth D. West, 2005.
"Approximately normal tests for equal predictive accuracy in nested models,"
Research Working Paper
RWP 05-05, Federal Reserve Bank of Kansas City.
- Clark, Todd E. & West, Kenneth D., 2007. "Approximately normal tests for equal predictive accuracy in nested models," Journal of Econometrics, Elsevier, vol. 138(1), pages 291-311, May.
- Kenneth D. West & Todd Clark, 2006. "Approximately Normal Tests for Equal Predictive Accuracy in Nested Models," NBER Technical Working Papers 0326, National Bureau of Economic Research, Inc.
- Pincheira, Pablo & García, Álvaro, 2012. "En busca de un buen marco de referencia predictivo para la inflación en Chile," El Trimestre Económico, Fondo de Cultura Económica, vol. 0(313), pages 85-123, enero-mar.
- Groen, Jan J.J. & Kapetanios, George & Price, Simon, 2009. "A real time evaluation of Bank of England forecasts of inflation and growth," International Journal of Forecasting, Elsevier, vol. 25(1), pages 74-80.
- Pablo Pincheira & Carlos A. Medel, 2012. "Forecasting Inflation with a Simple and Accurate Benchmark: a Cross-Country Analysis," Working Papers Central Bank of Chile 677, Central Bank of Chile.
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