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Forecasting Long-Term Interest Rates with a Dynamic General Equilibrium Model of the Euro Area: The Role of the Feedback

  • Paolo Zagaglia

    ()

    (Department of Economics, University of Bologna)

This paper studies the forecasting performance of the general equilibrium model of bond yields of Marzo, Söderström and Zagaglia (2008), where long-term interest rates are an integral part of the monetary transmission mechanism. The model is estimated with Bayesian methods on Euro area data. I compare the out-of-sample predictive performance of the model against a variety of competing specifications, including that of De Graeve, Emiris and Wouters (2009). Forecast accuracy is evaluated through both univariate and multivariate measures. I also control the statistical significance of the forecast differences using the tests of Diebold and Mariano (1995), Hansen (2005) and White (1980). I show that taking into account the impact of the term structure of interest rates on the macroeconomy generates superior out-of-sample forecasts for both real variables, such as output, and inflation, and for bond yields.

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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 19_11.

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Date of creation: Mar 2011
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Handle: RePEc:rim:rimwps:19_11
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  1. Seonghoon Cho & Antonio Moreno & Geert Bekaert, 2005. "New-Keynesian Macroeconomics and the Term Structure," Faculty Working Papers 04/05, School of Economics and Business Administration, University of Navarra.
  2. Tao Wu & Glenn Rudebusch, 2004. "A Macro-Finance Model of the Term Structure, Monetary Policy, and the Economy," 2004 Meeting Papers 104, Society for Economic Dynamics.
  3. Francis X. Diebold & Robert S. Mariano, 1994. "Comparing Predictive Accuracy," NBER Technical Working Papers 0169, National Bureau of Economic Research, Inc.
  4. Ravenna , Federico & Seppälä , Juha, 2006. "Monetary policy and rejections of the expectations hypothesis," Research Discussion Papers 25/2006, Bank of Finland.
  5. Francis X. Diebold & Monika Piazzesi & Glenn D. Rudebusch, 2005. "Modeling Bond Yields in Finance and Macroeconomics," PIER Working Paper Archive 05-008, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  6. Adolfson, Malin & Laséen, Stefan & Lindé, Jesper & Villani, Mattias, 2005. "Bayesian Estimation of an Open Economy DSGE Model with Incomplete Pass-Through," Working Paper Series 179, Sveriges Riksbank (Central Bank of Sweden).
  7. Malin Adolfson & Jesper Linde & Mattias Villani, 2007. "Forecasting Performance of an Open Economy DSGE Model," Econometric Reviews, Taylor & Francis Journals, vol. 26(2-4), pages 289-328.
  8. Glenn D. Rudebusch & Tao Wu, 2007. "Accounting for a Shift in Term Structure Behavior with No-Arbitrage and Macro-Finance Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 395-422, 03.
  9. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
  10. Diebold, Francis X. & Rudebusch, Glenn D. & Borag[caron]an Aruoba, S., 2006. "The macroeconomy and the yield curve: a dynamic latent factor approach," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 309-338.
  11. Kadiyala, K. Rao & Karlsson, Sune, 1994. "Numerical Aspects of Bayesian VAR-modeling," SSE/EFI Working Paper Series in Economics and Finance 12, Stockholm School of Economics.
  12. Moench, Emanuel, 2008. "Forecasting the yield curve in a data-rich environment: A no-arbitrage factor-augmented VAR approach," Journal of Econometrics, Elsevier, vol. 146(1), pages 26-43, September.
  13. Peter Hordahl & Oreste Tristani & David Vestin, 2003. "A joint econometric model of macroeconomic and term structure," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  14. Bauwens, Luc & Lubrano, Michel & Richard, Jean-Francois, 2000. "Bayesian Inference in Dynamic Econometric Models," OUP Catalogue, Oxford University Press, number 9780198773139.
  15. Floden, Martin, 2000. "Endogenous monetary policy and the business cycle," European Economic Review, Elsevier, vol. 44(8), pages 1409-1429, August.
  16. Glenn D. Rudebusch & Eric T. Swanson, 2008. "Examining the bond premium puzzle with a DSGE model," Working Paper Series 2007-25, Federal Reserve Bank of San Francisco.
  17. Juha Seppala & Federico Ravenna, 2007. "Monetary Policy, Expected Inflation, and Inflation Risk Premium," 2007 Meeting Papers 513, Society for Economic Dynamics.
  18. Eric M. Leeper & Christopher A. Sims, 1994. "Toward a modern macroeconomic model usable for policy analysis," FRB Atlanta Working Paper No. 94-5, Federal Reserve Bank of Atlanta.
  19. Glenn D. Rudebusch & Brian P. Sack & Eric T. Swanson, 2006. "Macroeconomic implications of changes in the term premium," Working Paper Series 2006-46, Federal Reserve Bank of San Francisco.
  20. Favara, Giovanni & Giordani, Paolo, 2009. "Reconsidering the role of money for output, prices and interest rates," Journal of Monetary Economics, Elsevier, vol. 56(3), pages 419-430, April.
  21. Marc P. Giannoni & Jean Boivin, 2005. "DSGE Models in a Data-Rich Environment," Computing in Economics and Finance 2005 431, Society for Computational Economics.
  22. De Graeve, Ferre & Emiris, Marina & Wouters, Raf, 2009. "A structural decomposition of the US yield curve," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 545-559, May.
  23. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March.
  24. Andrew B. Abel & Janice C. Eberly & Stavros Panageas, 2007. "Optimal Inattention to the Stock Market," American Economic Review, American Economic Association, vol. 97(2), pages 244-249, May.
  25. Kim, Jinill, 2000. "Constructing and estimating a realistic optimizing model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 45(2), pages 329-359, April.
  26. Missale, Alessandro, 1999. "Public Debt Management," OUP Catalogue, Oxford University Press, number 9780198290858.
  27. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
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