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Forecasting output gaps in the G-7 countries: The role of correlated Innovations and structural breaks

Trend GDP and output gaps play an important role in fiscal and monetary policy formulation, often including the need for forecasts. In this paper we focus on fore- casting trend GDP and output gaps with Beveridge-Nelson (1981) trend-cycle decompositions and investigate how these are affected by assumptions concern- ing correlated innovations and structural breaks. We evaluate expanding win- dows, one-step-ahead forecasts indirectly for the G-7 countries on the basis of real GDP growth rate forecasts. We find that correlated innovations affect real GDP growth rate forecasts positively, while allowing for structural breaks works for some countries but not for all. In the face of uncertainty the evidence supports that in making forecasts of trends and output gap policy makers should focus on allowing for the correlation of shocks as an order of priority higher than unknown structural breaks.

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File URL: http://eprints.utas.edu.au/23396/1/2016_04_Forecasting_Output_Gaps.pdf
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Paper provided by University of Tasmania, Tasmanian School of Business and Economics in its series Working Papers with number 2016-04.

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Length: 23 pages
Date of creation: 2016
Publication status: Published by the University of Tasmania. Discussion paper 2016-04
Handle: RePEc:tas:wpaper:23396
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Web page: http://www.utas.edu.au/business-and-economics

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  1. Perron, Pierre & Wada, Tatsuma, 2009. "Let's take a break: Trends and cycles in US real GDP," Journal of Monetary Economics, Elsevier, vol. 56(6), pages 749-765, September.
  2. Kiley, Michael T., 2013. "Output gaps," Journal of Macroeconomics, Elsevier, vol. 37(C), pages 1-18.
  3. Wieland, Volker & Wolters, Maik, 2013. "Forecasting and Policy Making," Handbook of Economic Forecasting, Elsevier.
  4. Basistha, Arabinda & Nelson, Charles R., 2007. "New measures of the output gap based on the forward-looking new Keynesian Phillips curve," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 498-511, March.
  5. Pesaran, M. Hashem & Pick, Andreas & Pranovich, Mikhail, 2013. "Optimal forecasts in the presence of structural breaks," Journal of Econometrics, Elsevier, vol. 177(2), pages 134-152.
  6. Tommaso Proietti, 2006. "Trend-Cycle Decompositions with Correlated Components," Econometric Reviews, Taylor & Francis Journals, vol. 25(1), pages 61-84.
  7. Jana Eklund & George Kapetanios & Simon Price, 2013. "Robust Forecast Methods and Monitoring during Structural Change," Manchester School, University of Manchester, vol. 81, pages 3-27, October.
  8. Jushan Bai & Pierre Perron, 1998. "Estimating and Testing Linear Models with Multiple Structural Changes," Econometrica, Econometric Society, vol. 66(1), pages 47-78, January.
  9. Mitra, Sinchan & Sinclair, Tara M., 2012. "Output Fluctuations In The G-7: An Unobserved Components Approach," Macroeconomic Dynamics, Cambridge University Press, vol. 16(03), pages 396-422, June.
  10. Clark, Todd E. & West, Kenneth D., 2007. "Approximately normal tests for equal predictive accuracy in nested models," Journal of Econometrics, Elsevier, vol. 138(1), pages 291-311, May.
  11. Giraitis, Liudas & Kapetanios, George & Price, Simon, 2013. "Adaptive forecasting in the presence of recent and ongoing structural change," Journal of Econometrics, Elsevier, vol. 177(2), pages 153-170.
  12. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, vol. 7(2), pages 151-174.
  13. Pesaran, M. Hashem & Timmermann, Allan, 2004. "How costly is it to ignore breaks when forecasting the direction of a time series?," International Journal of Forecasting, Elsevier, vol. 20(3), pages 411-425.
  14. Peter K. Clark, 1987. "The Cyclical Component of U. S. Economic Activity," The Quarterly Journal of Economics, Oxford University Press, vol. 102(4), pages 797-814.
  15. Shigeru Iwata & Han Li, 2015. "What are the Differences in Trend Cycle Decompositions by Beveridge and Nelson and by Unobserved Component Models?," Econometric Reviews, Taylor & Francis Journals, vol. 34(1-2), pages 146-173, February.
  16. Jushan Bai & Pierre Perron, 2003. "Computation and analysis of multiple structural change models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 18(1), pages 1-22.
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