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Forecasting inflation with dynamic factor model – the case of Poland

Author

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  • Jacek Kotlowski

    () (Warsaw School of Economics, National Bank of Poland)

Abstract

The purpose of the article is to evaluate the forecasting performance of dynamic factor models in forecasting inflation in the Polish economy. The factor models are based on the assumption that the behavior of most macroeconomic variables can be well described by several unobservable factors, which are often interpreted as the driving factors in the economy. Such models are very often successfully used for forecasting. Employing several factors instead of a large number of explanatory variables may increase the number of degrees of freedom with the same information content. In the article we compare forecast accuracy of dynamic factor models with the forecast accuracy of three competitive models: univariate autoregressive model, VAR model and the model with leading indicator from the business survey. We have used 92 monthly time series from the Polish and world economy to conduct the out-of-sample real time forecasts of inflation (consumer price index). The results are encouraging. The dynamic factor model outperforms other models for both 1-step ahead and 3-step ahead forecast. The advantage of factor models is more straightforward for 1-month than for 3-month horizon.

Suggested Citation

  • Jacek Kotlowski, 2008. "Forecasting inflation with dynamic factor model – the case of Poland," Working Papers 24, Department of Applied Econometrics, Warsaw School of Economics.
  • Handle: RePEc:wse:wpaper:24
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    File URL: http://kolegia.sgh.waw.pl/pl/KAE/struktura/IE/struktura/ZES/Documents/Working_Papers/aewp02-08.pdf
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    Citations

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    Cited by:

    1. Michal Brzoza-Brzezina & Jacek Kotlowski, 2009. "Estimating pure inflation in the Polish economy," Working Papers 37, Department of Applied Econometrics, Warsaw School of Economics.
    2. Jaroslaw Krajewski, 2009. "Estimating and Forecasting GDP in Poland with Dynamic Factor Model," Dynamic Econometric Models, Uniwersytet Mikolaja Kopernika, vol. 9, pages 139-145.

    More about this item

    Keywords

    inflation; forecasting; factor models;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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