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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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  10. Svensson, Lars E O, 1998. "Open-Economy Inflation Targeting," CEPR Discussion Papers 1989, C.E.P.R. Discussion Papers.
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  13. James H. Stock & Mark W.Watson, 2003. "Forecasting Output and Inflation: The Role of Asset Prices," Journal of Economic Literature, American Economic Association, vol. 41(3), pages 788-829, September.
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  24. 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.
  25. Paul Conway & Ben Hunt, 1997. "Estimating potential output: a semi-structural approach," Reserve Bank of New Zealand Discussion Paper Series G97/9, Reserve Bank of New Zealand.
  26. 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.
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