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Phillips curve forecasting in a small open economy

Stock and Watson (1999) show that the Phillips curve is a good forecasting tool in the United States. We assess whether this good performance extends to two small open economies, with relatively large tradable sectors. Using data for Australia and New Zealand, we find that the open economy Phillips curve performs poorly relative to a univariate autoregressive benchmark. However, its performance improves markedly when sectoral Phillips curves are used which model the tradable and non-tradable sectors separately. Combining forecasts from these sectoral models is much better than obtaining forecasts from a Phillips curve estimated on aggregate data. We also find that a diffusion index that combines a large number of indicators of real economic activity provides better forecasts of non-tradable inflation than more conventional measures of real demand, thus supporting Stock and Watson's (1999) findings for the United States.

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File URL: http://www.rbnz.govt.nz/research_and_publications/discussion_papers/2006/dp06_01.pdf
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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2006/01.

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Length: 20 p.
Date of creation: Feb 2006
Date of revision:
Handle: RePEc:nzb:nzbdps:2006/01
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  1. 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.
  2. Michael B. Devereux & Philip Lane, 2001. "Exchange Rates and Monetary Policy in Emerging Market Economies," CEG Working Papers 20017, Trinity College Dublin, Department of Economics.
  3. Todd E. Clark & Michael W. McCracken, 1999. "Tests of equal forecast accuracy and encompassing for nested models," Research Working Paper 99-11, Federal Reserve Bank of Kansas City.
  4. Stock, James H. & Watson, Mark W., 1999. "Forecasting inflation," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 293-335, October.
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  8. Athanasios Orphanides & Simon van Norden, 2003. "The Reliability of Inflation Forecasts Based on Output Gap Estimates in Real Time," CIRANO Working Papers 2003s-01, CIRANO.
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  10. De Gregorio, Jose & Giovannini, Alberto & Wolf, Holger C., 1994. "International evidence on tradables and nontradables inflation," European Economic Review, Elsevier, vol. 38(6), pages 1225-1244, June.
  11. 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.
  12. Laxton, Douglas & Pesenti, Paolo, 2003. "Monetary rules for small, open, emerging economies," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1109-1146, July.
  13. Todd E. Clark & Michael W. McCracken, 2003. "The predictive content of the output gap for inflation : resolving in-sample and out-of-sample evidence," Research Working Paper RWP 03-06, Federal Reserve Bank of Kansas City.
  14. James H. Stock & Mark W. Watson, 2001. "Forecasting output and inflation: the role of asset prices," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  15. Lars E. O. Svensson, 2000. "Open-Economy Inflation Targeting," NBER Working Papers 6545, National Bureau of Economic Research, Inc.
  16. Stock, James H & Watson, Mark W, 2002. "Macroeconomic Forecasting Using Diffusion Indexes," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(2), pages 147-62, April.
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  19. Batini, Nicoletta & Jackson, Brian & Nickell, Stephen, 2005. "An open-economy new Keynesian Phillips curve for the U.K," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1061-1071, September.
  20. Marcellino, Massimiliano & Stock, James H & Watson, Mark W, 2005. "A Comparison of Direct and Iterated Multistep AR Methods for Forecasting Macroeconomic Time Series," CEPR Discussion Papers 4976, C.E.P.R. Discussion Papers.
  21. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  22. Kenneth D. West, 1994. "Asymptotic Inference About Predictive Ability," Macroeconomics 9410002, EconWPA.
  23. Linde, Jesper, 2005. "Estimating New-Keynesian Phillips curves: A full information maximum likelihood approach," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1135-1149, September.
  24. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 134-44, January.
  25. Tim Robinson & Andrew Stone & Marileze van Zyl, 2003. "The Real-time Forecasting Performance of Phillips Curves," RBA Research Discussion Papers rdp2003-12, Reserve Bank of Australia.
  26. Massimiliano Marcellino & James H. Stock & Mark W. Watson, . "Macroeconomic Forecasting in the Euro Area: Country Specific versus Area-Wide Information," Working Papers 201, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  27. Chong, Yock Y & Hendry, David F, 1986. "Econometric Evaluation of Linear Macro-Economic Models," Review of Economic Studies, Wiley Blackwell, vol. 53(4), pages 671-90, August.
  28. Alfred V. Guender, 2006. "Stabilising Properties of Discretionary Monetary Policies in a Small Open Economy," Economic Journal, Royal Economic Society, vol. 116(508), pages 309-326, 01.
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