A Dynamic Factor Model for Forecasting Macroeconomic Variables in South Africa
This paper uses Dynamic Factor Models (DFMs), estimated under both classical and Bayesian assumptions, which accommodates a large cross-section of macroeconomic time series for forecasting per capita growth rate, inflation, and the nominal short-term interest rate for the South African economy. The DFMs used in this study contains 267 quarterly series observed over the period of 1980Q1-2006Q4. The results, based on the RMSEs of one- to four-quarters-ahead out of sample forecasts over 2001Q1 to 2006Q4, indicate that the DFMs significantly outperform alternative models such as an unrestricted VAR, Bayesian VARs (BVARs) and a typical New Keynesian Dynamic Stochastic General Equilibrium (NKDSGE) model in forecasting the three variables under consideration, hence, indicating the blessings of dimensionality.
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