Inflation forecast in Argentina: Individual models or pooling of forecasts?

Working papers | 2008 | N 35

Abstract

Inflation forecasting plays a central role in the formulation of monetary policy. At the same time, recent international empirical evidence suggests that with the decline in inflation in recent years, as a fairly widespread phenomenon, the joint dynamics of this variable and its potential predictors, such as money or different measures of the degree of use of resources , has changed and inflation has become more unpredictable. Using a univariate model as a benchmark, we evaluate the predictive capacity of some causal models associated with different theories of inflation, such as the Phillips curve and a monetary VAR. We also study the predictive capacity of models that use as predictors factors that summarize the joint variability of a large number of economic cycle series. We compared their relative performance using a set of parametric and non-parametric tests proposed by Diebold and Mariano (1995). We find that although the univariate model is generally the best performing, as the forecast horizon extends, the multivariate models approach the performance of the univariate ones. In particular, a monetary VAR outperforms the univariate ARMA model for a one-year horizon. However, when tests are calculated to evaluate the statistical significance of the differences in the predictive capacity of the models, taking a univariate ARMA model as a benchmark, the differences are not statistically significant. Finally, the estimated models are combined through a pool of forecasts. The results indicate that some of the forecast combinations outperform the best individual forecast for a one-year horizon. Taking into account that the horizon of one year is the relevant one for making economic policy decisions, the possibility of combining both univariate and multivariate models for forecasting is interesting because it also allows us to answer specific economic policy questions.

JEL classification: C32, E31, E37