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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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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. Holger C. Wolf & Alberto Giovannini & Jose De Gregorio, 1994. "International Evidenceon Tradables and Nontradables Inflation," IMF Working Papers 94/33, International Monetary Fund.
  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. Massimiliano Marcellino & James Stock & Mark Watson, 2005. "A Comparison of Direct and Iterated Multistep AR Methods for Forecasting Macroeconomic Time Series," Working Papers 285, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
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  8. Matheson, Troy, 2010. "Assessing the fit of small open economy DSGEs," Journal of Macroeconomics, Elsevier, vol. 32(3), pages 906-920, September.
  9. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers 638, Stockholm - International Economic Studies.
  10. Kenneth D. West, 1994. "Asymptotic Inference About Predictive Ability," Macroeconomics 9410002, EconWPA.
  11. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 253-63, July.
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  13. Todd E. Clark & Michael McCracken, 1999. "Tests of Equal Forecast Accuracy and Encompassing for Nested Models," Computing in Economics and Finance 1999 1241, Society for Computational Economics.
  14. Douglas Laxton & Paolo Pesenti, 2003. "Monetary Rules for Small, Open, Emerging Economies," NBER Working Papers 9568, National Bureau of Economic Research, Inc.
  15. 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.
  16. 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, vol. 47(1), pages 1-18, February.
  17. 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.
  18. Lindé, Jesper, 2001. "Estimating New-Keynesian Phillips Curves: A Full Information Maximum Likelihood Approach," Working Paper Series 129, Sveriges Riksbank (Central Bank of Sweden), revised 30 Apr 2001.
  19. 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.
  20. Michael W. McCracken & Todd E. Clark, 2003. "The Predictive Content of the Output Gap for Inflation: Resolving In-Sample and Out-of-Sample Evidence," Computing in Economics and Finance 2003 183, Society for Computational Economics.
  21. 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.
  22. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
  23. Canova, Fabio, 1998. "Detrending and business cycle facts," Journal of Monetary Economics, Elsevier, vol. 41(3), pages 475-512, May.
  24. 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.
  25. James H. Stock & Mark W. Watson, 1999. "Forecasting Inflation," NBER Working Papers 7023, National Bureau of Economic Research, Inc.
  26. 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.
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