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Forecasting Macroeconomic Variables in a Small Open Economy: A Comparison between Small- and Large-Scale Models

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  • Rangan Gupta

    () (Department of Economics, University of Pretoria)

  • Alain Kabundi

    () (Department of Economics and Econometrics, University of Johannesburg)

Abstract

This paper compares the forecasting ability of five alternative types of models in predicting four key macroeconomic variables, namely, per capita growth rate, the CPI inflation, the money market rate, and the growth rate of the nominal effective exchange rate for the South African economy. Unlike the theoretical Small Open Economy New Keynesian Dynamic Stochastic General Equilibrium, the unrestricted VAR, and the small-scale Bayesian Vector Autoregressive models, which are estimated based on four variables, Dynamic Factor Models and the large-scale BVAR models use information from a data-rich environment containing 266 macroeconomic time series observed over the period of 1983:01 to 2002:04. The results, based on Root Mean Square Errors, for one- to eight-quarters-ahead out-of-sample forecasts over the horizon of 2003:01 to 2006:04, show that, except for the growth rate of the of nominal effective exchange rate, large-scale BVARs outperform the other four types of models consistently and, generally, significantly.

Suggested Citation

  • Rangan Gupta & Alain Kabundi, 2008. "Forecasting Macroeconomic Variables in a Small Open Economy: A Comparison between Small- and Large-Scale Models," Working Papers 200830, University of Pretoria, Department of Economics.
  • Handle: RePEc:pre:wpaper:200830
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    References listed on IDEAS

    as
    1. Rangan Gupta, 2006. "FORECASTING THE SOUTH AFRICAN ECONOMY WITH VARs AND VECMs," South African Journal of Economics, Economic Society of South Africa, vol. 74(4), pages 611-628, December.
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    6. Rangan Gupta & Alain Kabundi, 2008. "A Dynamic Factor Model for Forecasting Macroeconomic Variables in South Africa," Working Papers 200815, University of Pretoria, Department of Economics.
    7. Rangan Gupta & Moses m. Sichei, 2006. "A Bvar Model For The South African Economy," South African Journal of Economics, Economic Society of South Africa, vol. 74(3), pages 391-409, September.
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    11. Guangling 'Dave' Liu & Rangan Gupta & Eric Schaling, 2009. "A New-Keynesian DSGE model for forecasting the South African economy," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 28(5), pages 387-404.
    12. Gupta, Rangan & Kabundi, Alain, 2011. "Forecasting Macroeconomic Variables Using Large Datasets: Dynamic Factor Model versus Large-Scale BVARs," Indian Economic Review, Department of Economics, Delhi School of Economics, vol. 46(1), pages 23-40.
    13. Rangan Gupta & Sonali Das, 2008. "Spatial Bayesian Methods Of Forecasting House Prices In Six Metropolitan Areas Of South Africa," South African Journal of Economics, Economic Society of South Africa, vol. 76(2), pages 298-313, June.
    14. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
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    16. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
    17. Perron, Pierre & Rodriguez, Gabriel, 2003. "GLS detrending, efficient unit root tests and structural change," Journal of Econometrics, Elsevier, pages 1-27.
    18. Jean Boivin & Serena Ng, 2005. "Understanding and Comparing Factor-Based Forecasts," International Journal of Central Banking, International Journal of Central Banking, vol. 1(3), December.
    19. De Mol, Christine & Giannone, Domenico & Reichlin, Lucrezia, 2008. "Forecasting using a large number of predictors: Is Bayesian shrinkage a valid alternative to principal components?," Journal of Econometrics, Elsevier, vol. 146(2), pages 318-328, October.
    20. Mario Forni & Marc Hallin & Marco Lippi & Lucrezia Reichlin, 2000. "The Generalized Dynamic-Factor Model: Identification And Estimation," The Review of Economics and Statistics, MIT Press, vol. 82(4), pages 540-554, November.
    21. Zellner, Arnold, 1986. "A tale of forecasting 1001 series : The Bayesian knight strikes again," International Journal of Forecasting, Elsevier, vol. 2(4), pages 491-494.
    22. Rangan Gupta, 2007. "FORECASTING THE SOUTH AFRICAN ECONOMY WITH GIBBS SAMPLED BVECMs," South African Journal of Economics, Economic Society of South Africa, vol. 75(4), pages 631-643, December.
    23. Alberto Ortiz & Federico Sturzenegger, 2007. "Estimating Sarb'S Policy Reaction Rule," South African Journal of Economics, Economic Society of South Africa, vol. 75(4), pages 659-680, December.
    24. Sims, Christopher A & Stock, James H & Watson, Mark W, 1990. "Inference in Linear Time Series Models with Some Unit Roots," Econometrica, Econometric Society, vol. 58(1), pages 113-144, January.
    25. de Wet, Albertus H. & van Eyden, Reneé & Gupta, Rangan, 2009. "Linking global economic dynamics to a South African-specific credit risk correlation model," Economic Modelling, Elsevier, vol. 26(5), pages 1000-1011, September.
    26. Litterman, Robert B, 1986. "Forecasting with Bayesian Vector Autoregressions-Five Years of Experience," Journal of Business & Economic Statistics, American Statistical Association, vol. 4(1), pages 25-38, January.
    27. Bai, Jushan & Ng, Serena, 2007. "Determining the Number of Primitive Shocks in Factor Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 25, pages 52-60, January.
    28. Stock, James H & Watson, Mark W, 2002. "Macroeconomic Forecasting Using Diffusion Indexes," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(2), pages 147-162, April.
    29. Rangan Gupta, 2009. "Bayesian Methods Of Forecasting Inventory Investment," South African Journal of Economics, Economic Society of South Africa, vol. 77(1), pages 113-126, March.
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    Citations

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    Cited by:

    1. Mehmet Balcilar & Rangan Gupta & Clement Kyei & Mark E. Wohar, 2016. "Does Economic Policy Uncertainty Predict Exchange Rate Returns and Volatility? Evidence from a Nonparametric Causality-in-Quantiles Test," Open Economies Review, Springer, vol. 27(2), pages 229-250, April.
    2. Bekiros, Stelios & Cardani, Roberta & Paccagnini, Alessia & Villa, Stefania, 2016. "Dealing with financial instability under a DSGE modeling approach with banking intermediation: A predictability analysis versus TVP-VARs," Journal of Financial Stability, Elsevier, vol. 26(C), pages 216-227.
    3. Karlsson, Sune, 2013. "Forecasting with Bayesian Vector Autoregression," Handbook of Economic Forecasting, Elsevier.
    4. Gupta, Rangan & Steinbach, Rudi, 2013. "A DSGE-VAR model for forecasting key South African macroeconomic variables," Economic Modelling, Elsevier, vol. 33(C), pages 19-33.
    5. Balcilar, Mehmet & Gupta, Rangan & Kotzé, Kevin, 2015. "Forecasting macroeconomic data for an emerging market with a nonlinear DSGE model," Economic Modelling, Elsevier, vol. 44(C), pages 215-228.
    6. Mirriam Chitalu Chama-Chiliba & Rangan Gupta & Nonophile Nkambule & Naomi Tlotlego, 2011. "Forecasting Key Macroeconomic Variables of the South African Economy Using Bayesian Variable Selection," Working Papers 201132, University of Pretoria, Department of Economics.
    7. Mehmet Balcilar & Rangan Gupta & Kevin Kotze, 2013. "Forecasting South African Macroeconomic Data with a Nonlinear DSGE Model," Working Papers 201313, University of Pretoria, Department of Economics.
    8. Rangan Gupta & Alain Kabundi & Stephen M. Miller, 2009. "Using Large Data Sets to Forecast Housing Prices: A Case Study of Twenty US States," Working Papers 200912, University of Pretoria, Department of Economics.
    9. Marcin Kolasa & Michal Rubaszek, 2016. "Does foreign sector help forecast domestic variables in DSGE models?," Working Papers 2016-022, Warsaw School of Economics, Collegium of Economic Analysis.
    10. Patrick T. Kanda & Mehmet Balcilar & Pejman Bahramian & Rangan Gupta, 2016. "Forecasting South African inflation using non-linearmodels: a weighted loss-based evaluation," Applied Economics, Taylor & Francis Journals, vol. 48(26), pages 2412-2427, June.
    11. Rangan Gupta, 2012. "Forecasting House Prices for the Four Census Regions and the Aggregate US Economy: The Role of a Data-Rich Environment," Working Papers 201214, University of Pretoria, Department of Economics.
    12. Annari De Waal & Reneé Van Eyden & Rangan Gupta, 2015. "Do we need a global VAR model to forecast inflation and output in South Africa?," Applied Economics, Taylor & Francis Journals, vol. 47(25), pages 2649-2670, May.
    13. Rangan Gupta & Rudi Steinbach, 2010. "Forecasting Key Macroeconomic Variables of the South African Economy: A Small Open Economy New Keynesian DSGE-VAR Model," Working Papers 201019, University of Pretoria, Department of Economics.
    14. Goodness C. Aye & Mehmet Balcilar & Adél Bosch & Rangan Gupta & Francois Stofberg, 2013. "The out-of-sample forecasting performance of non-linear models of real exchange rate behaviour: The case of the South African Rand," European Journal of Comparative Economics, Cattaneo University (LIUC), vol. 10(1), pages 121-148, April.
    15. Rangan Gupta & Patrick Kanda & Mampho Modise & Alessia Paccagnini, 2013. "DGSE Model-Based Forecasting of Modeled and Non-Modeled Inflation Variables in South Africa," Working Papers 259, University of Milano-Bicocca, Department of Economics, revised Nov 2013.
    16. Riané de Bruyn & Rangan Gupta & Reneé van Eyden, 2015. "Can We Beat the Random-Walk Model for the South African Rand--U.S. Dollar and South African Rand--UK Pound Exchange Rates? Evidence from Dynamic Model Averaging," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 51(3), pages 502-524, May.
    17. Riane de Bruyn & Rangan Gupta & Renee van Eyden, 2013. "Forecasting The Rand-Dollar And Rand-Pound Exchange Rates Using Dynamic Model Averaging," Working Papers 201307, University of Pretoria, Department of Economics.
    18. Stelios Bekiros & Alessia Paccagnini, 2013. "On the predictability of time-varying VAR and DSGE models," Empirical Economics, Springer, vol. 45(1), pages 635-664, August.
    19. Sami Alpanda & Kevin Kotzé & Geoffrey Woglom, 2011. "Forecasting Performance Of An Estimated Dsge Model For The South African Economy," South African Journal of Economics, Economic Society of South Africa, vol. 79(1), pages 50-67, March.
    20. Bekiros, Stelios, 2014. "Forecasting with a state space time-varying parameter VAR model: Evidence from the Euro area," Economic Modelling, Elsevier, vol. 38(C), pages 619-626.
    21. repec:mes:emfitr:v:51:y:2015:i:3:p:502-524 is not listed on IDEAS
    22. Hyeyoen Kim & Doojin Ryu, 2013. "Forecasting Exchange Rate from Combination Taylor Rule Fundamental," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 49(S4), pages 81-92, September.
    23. Musso, Alberto & Neri, Stefano & Stracca, Livio, 2011. "Housing, consumption and monetary policy: How different are the US and the euro area?," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 3019-3041, November.
    24. Dimitris P. Louzis, 2014. "Macroeconomic and credit forecasts in a small economy during crisis: A large Bayesian VAR approach," Working Papers 184, Bank of Greece.

    More about this item

    Keywords

    Small Open Economy New Keynesian Dynamic Stochastic Model; Dynamic Factor Model; VAR; BVAR; Forecast Accuracy;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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