Economic Forecasting
Economic Forecasting
Economic Forecasting
CENTRAL
BANK
W O R K I N G PA P E R S E R I E S
EUROPEAN
CENTRAL
BANK
W O R K I N G PA P E R S E R I E S
Financial support from the U.K. Economic and Social Research Council under grant R000233447 is gratefully acknowledged. We are indebted to participants at the ECB
Conference on Forecasting Techniques for helpful comments on an earlier draft. Computations were performed using PcGive and the Gauss programming language, Aptech Systems,
Inc.,Washington.This paper has been presented at the ECB workshop on Forecasting Techniques, held in September 2001.
Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany
Postal address
Postfach 16 03 19
D-60066 Frankfurt am Main
Germany
Telephone
+49 69 1344 0
Internet
http://www.ecb.int
Fax
Telex
Contents
Abstract
1 Introduction
2 Background
2.1 The failure of optimality theory
7
8
9
10
11
11
12
12
12
13
13
13
14
14
14
15
16
16
16
16
17
17
17
20
22
22
23
23
23
25
25
26
8 Conclusions
26
References
26
33
Abstract
This paper describes some recent advances and contributions to our understanding of economic forecasting.
The framework we develop helps explain the findings of forecasting competitions and the prevalence of
forecast failure. It constitutes a general theoretical background against which recent results can be judged.
We compare this framework to a previous formulation, which was silent on the very issues of most concern
to the forecaster. We describe a number of aspects which it illuminates, and draw out the implications for
model selection. Finally, we discuss the areas where research remains needed to clarify empirical findings
which lack theoretical explanations.
JEL classification system: C32
Keywords: Forecasting; structural breaks; model selection; forecast-error taxonomy.
1 Introduction
A forecast is any statement about the future, so economic forecasting is a vast subject. To be really
successful at forecasting, one requires a crystal ball that reveals the future: unfortunately, these appear
to be unavailable as the Washington Times headlined in relation to the probability of a recession
in the USA, Never a crystal ball when you need one.1 Consequently, we focus on extrapolating
from present information using systematic forecasting rules. While many such extrapolative methods
do at least exist, they face the difficulty that the future is uncertain for two reasons. The first is
uncertainty where we understand the probabilities involved, so can incorporate these in (say) measures
of forecast uncertainty. The second is uncertainties we do not currently understand, and is the more
serious problem, particularly in economics where non-stationary behaviour is the norm as Clements
and Hendry (1999a) quote:
Because of the things we dont know we dont know, the future is largely unpredictable.
Singer (1997, p. 39)
Empirical models can take into account the effects of earlier events even though these were unanticipated at the time and so explain the past quite well. However, new unpredictable events will occur in
the future, so the future will always appear more uncertain than the past. Any operational theory of economic forecasting must allow for such contingencies, where any of the data moments (especially levels
and variability) of I(0) transformations of economic variables might alter because of changes in technology, legislation, politics, weather, and society: Stock and Watson (1996) document the pervasiveness of
structural change in macroeconomic time-series.
Regular persistent changes are now modelled by stochastic trends, so unit roots are endemic in
econometric and forecasting models. Structural breaks defined as sudden large changes, invariably
unanticipated are a major source of forecast failure, namely a significant deterioration in forecast
performance relative to the anticipated outcome, usually based on the historical performance of a model.
To date, no generic approaches to modelling such breaks have evolved, although considerable effort is
being devoted to non-linear models, many of which primarily select rare events. Thus, in practice,
economic forecasts end up being a mixture of sciencebased on econometric systems that embody
consolidated economic knowledge and have been carefully evaluatedand art, namely judgments about
perturbations from recent unexpected events.
1
The theme of our paper is that recommendations about model types for forecasting, and associated
methods, need to be based on a general theory of economic forecasting that has excess empirical content.
First, section 2 sketches an earlier theoretical background which can loosely be equated to the textbook
treatment. Unfortunately, despite its mathematical elegance and the simplicity of its prescriptions, the
evidence against it providing a useful theory for economic forecasting cannot be ignored: see section
2.1. Section 3 then proposes a more viable framework based on Clements and Hendry (1999a), and
section 3.1 outlines the underlying forecast-error taxonomy. Proposals based on inducing principles
from the experience of forecast successes and failures are discussed in section 4. Ten areas where the
new theoretical framework appears to account for the evidence are investigated in section 5: the basis
for their selection is that we do not anticipate major changes in those areas. The implications of that
theory for model selection are then drawn in section 6. Section 7 considers ten areas where further
research remains a high priority, in many instances, already ongoing. Finally, section 8 provides some
concluding remarks. The results reported below draw on a number of published (or forthcoming) papers
and books. However, the paper does not claim to be complete in any sense, partly because the subject is
now advancing rapidly on many fronts.
2 Background
Historically, the theory of economic forecasting has relied on two key assumptions (see e.g., Klein,
1971):
(1) the model is a good representation of the economy, and
(2) the structure of the economy will remain relatively unchanged.
Given these assumptions, several important theorems can be proved, each with many testable implications: see Clements and Hendry (1998) for details and proofs. We refer to this as optimality theory
following Makridakis and Hibon (2000).
First, forecasts from such models will closely approximate the conditional expectation of the data,
so the best model generally produces the best forecasts. This entails that an in-sample congruent
encompassing model will dominate in forecasting. Moreover, for example, the only judgements that
should improve forecasts are those based on advance warnings of events to come (such as notice of
future tax changes or strikes). Further, it should not pay to pool forecasts across several models
indeed, pooling refutes encompassing and adding biased forecasts or those from a badly-fitting model
should merely serve to worsen (say) mean-square forecast errors (MSFEs).
Second, forecast accuracy should decline as the forecast horizon increases because more innovation
errors accrue and predictability falls. Interval forecasts calculated from in-sample estimates reflect this
property.2
Third, in-sample based interval forecasts should be a good guide to the likely variations in the forecast errors. Monte Carlo simulation evidence from studies embodying the two assumptions corroborate
this finding (see inter alia, Calzolari, 1981, and Chong and Hendry, 1986).
Given such a strong foundation, one might anticipate a successful history of economic forecasting.
The facts are otherwise.
2
Such confidence intervals from dynamic models need not be monotonically non-decreasing in the horizon, but this is a
technical issue see Chong and Hendry (1986).
t = 1, . . . , T,
(1)
where the indicator variable 1 +j = 1 for t [ , + j] and is zero otherwise. If the change at time is
not modelled, then in terms of first differences:
yt = 1 (1 1T ) + 2 1T + t
= (2 1 )1 + t ,
(2)
and the first term will add to the residual, so over the sample as a whole, there will not be a redundant
common factor of (1 L). The residuals are likely to be negatively autocorrelated in the absence of any
dynamic modelling, offset by any original positive autocorrelation in the {t }. So, the expected level of
yt changes from 1 to 2 at time , but the break produces only one non-zero blip of 2 1 at in the
first difference. It is easy to see that forecasts based on the first difference specification will be robust to
t+h|t + yt+h1|t ,
shifts. Write the h-step ahead forecast of the level of {y} from period t as yt+h|t = y
i.e., the forecast of the change plus the forecast level in period t+h1. Suppose h = 1 so that yt|t yt ,
then for t , E[
yt+1|t ] = 2 = E[yt+h|t ] (because E[y
t+1|t ] 0) proving unbiasedness. This result
generalizes for h > 1 by a recursive argument. As Osborn (2001) notes, the non-invertibility of the
4
Nevertheless, we welome the rapid increase in reporting of interval forecasts as an addition to point forecasts, and the use
of (e.g.) fan charts to represent uncertainty: Ericsson (2001) provides an exposition.
5
Clements and Hendry (1997) and Osborn (2001) provide analyses of differencing for seasonal data.
error term in the first-differenced model suggests that empirically lags are likely to be added to mop up
the serial correlation, which will lessen the adaptability of the model. Nevertheless, it is evident that
estimating (1) with an assumed constant mean will generate biased forecasts to an extent that depends
upon 2 1 and the timing of relative to the forecast origin.
Fundamentally, causal variables (variables that actually determine the outcome) cannot be proved to
help a models forecasts. After a shift, a previously well-specified model may forecast less accurately
than a model with no causal variables. This result helps explain the rankings in forecast competitions.
The best causal description of the economy may not be robust to sudden shifts, so loses to more adaptive
models for forecasting over periods when shifts occurred. Also, pooling can be beneficial because
different models are differentially affected by unanticipated shifts. Further, a levels shift can temporarily
contaminate a models short-term forecasts, but the effects wear off, so earlier longer-term forecasts of
growth rates can be more accurate than 1-step ahead forecasts made a few periods after a shift. Thus,
explanations of the empirical results are provided by the more general framework. By itself that does not
preclude alternative explanations, so section 3.1 investigates whether other potential sources of forecast
errors could account for the evidence.
3.1 A forecast-error taxonomy
Clements and Hendry (1998, 1999a) derive the following nine sources of forecast error as a comprehensive decomposition of deviations between announced forecasts and realized outcomes:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
Any one or combinations of these nine sources could cause serious forecast errors. However, theoretical analyses, Monte Carlo simulations, and empirical evidence all suggest that the first source is the
most pernicious, typically inducing systematic forecast failure. Clements and Hendry interpret shifts in
the coefficients of deterministic terms as shifts in the deterministic terms themselves, so the next most
serious problems are those which are equivalent to such deterministic shifts, including the third, fifth
and seventh sources. For example, omitting a linear trend or using a biased estimate of its coefficient are
equivalent forms of mistake, as may be data mis-measurement at the forecast origin in models where
such a measurement error mimics a deterministic shift.
Conversely, the other sources of forecast error have less damaging effects. For example, even quite
large shifts in the coefficients of mean-zero stochastic variables have small effects on forecast errors:
see Hendry and Doornik (1997), Hendry (2000b) and section 5.6. The last two sources in the taxonomy certainly reduce forecast accuracy, but large stochastic perturbations seem needed to precipitate
systematic forecast failure.
The optimality paradigm discussed in section 2 offers no explanation for observed forecast failures.
At various stages, bad forecasts have been attributed (especially in popular discussions, such as the
Press) to mis-specified models, poor methods, inaccurate data, incorrect estimation, data-based
model selection and so on, without those claims being proved: the research in Clements and Hendry
10
(1999a) demonstrate the lack of foundation for most such explanations, whereas the sources follow as
discussed above.
the role of causal variables, particularly when such variables are forecast by auxiliary models;
whether congruent models outperform non-congruent, and hence:
whether there is value-added in mis-specification testing when selecting forecasting models; and
whether cointegration restrictions improve forecasts.
However, all four of their unresolved issues have no generic answer: Clements and Hendry (1999a)
show that under the assumptions of section 3, causal variables cannot be proved to dominate noncausal; that congruent models need not outperform non-congruent, so rigorous mis-specification testing
need not help for selecting forecasting models; and that equilibrium-mean shifts induce forecast failure,
so cointegration will improve forecasting only if the equilibrium means remain constant. Conversely,
if an economy were reducible by transformations to a stationary stochastic process, so unconditional
moments remained constant over time, then well-tested, causally-relevant congruent models which embodied valid restrictions would both fit best, and by encompassing, dominate in forecasting on average.
Depending on the time periods examined, and the behaviour of the data therein, either state of nature
might hold, so ambiguous empirical findings can emerge.
Against this background, we now evaluate ten areas where explanations can be offered consistent
with the empirical evidence.
11
12
13
means are generally easy to detect. Using a VEqCM model class, he contrasts the ease of detection of
deterministic and stochastic shifts by Monte Carlo.
5.7 Explaining the results of forecasting competitions
The major forecasting competitions involve many hundreds of time series and large numbers of forecasting models. Makridakis and Hibon (2000) record the latest in a sequence of such competitions,
discussed by Clements and Hendry (2001c). Fildes and Ord (2001) consider the role such competitions
have played in improving forecasting practice and research, and conclude that the four main implications
of forecasting competitions are:
(a)
(b)
(c)
(d)
The explanation for the four findings in (a)(d) has three facets. The first facet is that economies
are non-stationary processes which are not reducible to stationarity by differencing, thereby generating
moments that are non-constant over time. The second facet is that some models are relatively robust to
deterministic shifts, either by transforming their impact into blips or by adapting rapidly to them. The
third facet is that most measures of forecast accuracy are not invariant under data transformations (see
Clements and Hendry, 1993).
We comment in section 5.8 on (a), but the combination of the first two facets is the key. The third
directly explains (b). However, (c) remains to be analytically modelled for general settings: see section
7.5. Finally, the evaluation horizon matters for all three reasons, because no method can be robust to
breaks that occur after forecasts are announced, so the shorter the horizon when breaks are intermittent,
the more that favours robust devices. This also appears to explain the findings in Eitrheim et al. (1999).
5.8 Simplicity in forecasting
An unfortunate confusion which has resulted from the findings of forecasting competitions is that simpler models do better: see e.g., Kennedy (2001). The source of the successful approaches is their adaptability (primarily to shifts in intercepts and trends), not their simplicity per se: Clements and Hendry
(1999b, 2001c) explain why. It just happens that, to date, many adaptive models have been simple.
Important examples include exponentially-weighted moving averages (EWMAs), or double-differenced
devices (same change forecasts, or 2 yT +1 = 0). A linear deterministic trend yT +1 = a + b (T + 1)
is a simple model which does badly in forecasting (see section 5.10), so simplicity alone is not the
relevant criterion. An important implication of the finding that adaptability dominates verisimilitude in
forecasting competitions is that ex ante forecasting comparisons should not be used to evaluate models
(except for forecasting): see section 6.1.
5.9 Evaluating forecasts
Forecast evaluation has long been based on statistical criteria, from examining moments such as forecast biases and variances through tests for efficiency and the related literature on forecast encompassing, to comparisons between different forecasting devices as discussed above. More recently, attention
has turned to the evaluation of forecasts when they are instrumental in decision taking, so an explicit loss
function for forecast errors defines the costs: see Granger (2001), Granger and Pesaran (2000a, 2000b),
14
and Pesaran and Skouras (2001). Consequently, the choice of forecasts depends on their purpose, as represented by the loss function, rather than just a statistical criterion: it seems natural that a stock broker
measures the value of forecasts by their monetary return, not their MSFE. This development also removes the ambiguity of evaluation based on (say) MSFE measures due to their lack of invariance under
linear transformations when the outcome is from a multi-variate or multi-horizon forecasting exercise
(see Clements and Hendry, 1993).
A related topic is the increased focus on density forecasting, where the complete probability distribution of possible future outcomes is forecast: see Tay and Wallis (2001) for a survey, Clements
and Smith (2000b) for a multi-step application comparing linear and non-linear models, and Diebold,
Gunther and Tay (1998) for the role of density forecasting in decision taking. Earlier reporting of
forecast-error means and variances only corresponded to a complete characterization of their density for
normal distributions. Most calculated fan charts correspond to that scenario, but that is not an inherent
feature, and asymmetric confidence intervals are discussed in Hatch (2001) and Tay and Wallis (2001)
(which they call prediction intervals).
The final aspect we note is that conditional heteroscedasticity may entail changing widths of forecast confidence intervals, induced by (say) autoregressive (ARCH: see Engle, 1982), general, or related
error processes (GARCH: see e.g., Bollerslev, Engle and Nelson, 1994), stochastic volatility (see inter alia, Kim, Shephard and Chib, 1998), or inherent in the model specification (see e.g., Richard and
Zhang, 1996). Granger, White and Kamstra (1989) and Christoffersen (1998) consider forecast confidence interval evaluation for dynamic intervals (that reflect the changing volatility of the ARCH-type
process) and Clements and Taylor (2000) consider methods appropriate for high-frequency data that
exhibit periodic volatility patterns.
5.10 Difference-stationary versus trend-stationary models
Difference-stationary (DS) and trend-stationary (TS) models have markedly different implications for
forecasting when the properties of each are derived as if it were the DGP: see Sampson (1991). However,
such a state of nature can never be actualized: only one model can be the DGP. Consequently, Clements
and Hendry (2001d) examine forecasting with the two models when the DGP is in turn either DS or TS,
so that the other model is then mis-specified. They consider known and estimated parameters, letting
the relation between the estimation sample, T , and the forecast horizon h vary. For known parameters,
when a TS process is the DGP, the forecast-error variances of both models are O(1); and when the DS
process is the DGP, both are O(h). Thus, the apparently very different properties of the models is due
purely to the behaviour of the DGPs: given the DGP, the models actually have similar behaviour. With
parameter-estimation uncertainty in the TS DGP, both models forecast-error variances increase as the
square of the horizon for fixed T , the DS/TS variance ratio goes to infinity as T increases but less
quickly than h whereas for faster rates of increase of T , the ratio converges to 2. For the DS DGP,
both the TS and DS models variances are of the same order: only when T increases at a faster rate than
h does the order of the TS model variance exceed that of the DS model. Their Monte Carlo simulations
corroborated these results, as well as the serious mis-calculation of the forecast confidence intervals
when the other model is the DGP.
In terms of section 3, when deterministic shifts occur, the DS model is considerably more adaptive
than the TS, which rapidly produces systematic forecast failure, exacerbated by the calculation of its
interval forecasts being far too narrow in I(1) processes: see Hendry (2001).
15
16
current practice in all four areas, but in this section, we are primarily concerned with the role of forecast
performance in selecting policy models, about which they draw two main conclusions:
being the best forecasting model does not justify its policy use; and
forecast failure is insufficient to reject a policy model.
The first holds because the class of models that wins forecasting competitions is usually badly
mis-specified in econometric terms, and rarely has any implications for economic-policy analysis, lacking both target variables and policy instruments. Moreover, intercept corrections could improve forecast
performance without changing policy advice, confirming their argument. The second holds because
forecast failure reflects unanticipated deterministic shifts, which need not (but could) affect policy conclusions. Thus, neither forecast success nor failure entails either good or bad policy advice: policy
models need policy evaluation.
Since shifts in policy regimes correspond to post-forecasting breaks for extrapolative devices,
Hendry and Mizon (2000a) note that neither econometric models nor time-series predictors alone are
adequate, and provide an empirical illustration of combining them.
6.4 Impulse-response analyses
The difficulty of detecting shifts in policy-relevant parameters has adverse implications for impulseresponse analyses. Many vector autoregressions (VARs) are formulated in the differences of economic
variables, so changes in their intercepts and coefficients may not be detected even if tested for. In such
a state of nature, full-sample estimates become a weighted average of the different regimes operating
in sub-samples, so may not represent the correct policy outcomes. Thus, the very breaks that are least
harmful in forecasting are most detrimental for policy advice. Since Hendry and Mizon (2000b) also
list a range of well-known problems with impulse-response analyses, it is clear that more reliable approaches are urgently required.
17
section we consider model adaptation using the simple expedient of an intercept correction, where the
issue of interest is whether pre-testing for a break can yield gains relative to their blanket application or,
conversely, no intervention.
Clements and Hendry (2001g) take just this set up, that is, forecasting is an ongoing venture, and
series of 1 to h-step ahead forecasts are made at each of a sequence of forecast origins. The historical
sample lengthens by one observation each time the forecast origin moves forward, so the possibility of
testing for structural change, and the action to be taken if it is detected, arises afresh. One testing strategy
is the repeated application of one-off tests for structural change. Alternatively, the sequential testing
procedures of Chu, Stinchcombe and White (1996) monitor for structural change as new observations
accrue. The overall size of a sequence of repeated tests will approach unity as the number of applications
(i.e., forecast origins) goes to infinity, whereas the Chu et al. (1996) sequential CUSUM test has the
correct asymptotic size by construction. Whether or not it is costly to falsely reject constancy will in
part depend on the form of the intervention to be made, but it is also likely that the sequential tests
will lack power when breaks do occur. A full investigation needs to be undertaken here we report an
example based on the repeated application of one-off tests. .
One possible strategy is automatic IC, whereby at each forecast origin, the forecasts are set back on
track, by making a correction to the equations intercepts based on the most recently observed errors.
Such a strategy is implemented by augmenting the model with a dummy variable which takes values of
unity in the last l periods. Thus, for a forecast origin T , and setting l = 1, this form of intervention is
equivalent to estimating the model on data up to time T 1. There are then two possibilities: a constant
adjustment and an impulse adjustment, depending on whether the dummy variable is assumed to take
the value of unity or zero over the period {T + 1, . . . , T + h}. In the first case, forecasts are generated
from a model corrected by the vector of in-sample errors at period T (again, assuming l = 1). In the
second case, when the dummy variable is zero over the forecast period, the correction only affects the
estimated parameters (by ignoring the period T observation when l = 1).
The form of the recommended correction will partly depend on the model, namely whether the
model is in levels, differences, or is a VEqCM (e.g., constant adjustments are likely to be a better
response to equilibrium-mean shifts in VEqCMs), and partly on the permanence of the break. The
timing, l, of the first unit value in the dummy will depend on the point at which the break occurred,
the trade-off between forecast-error bias reduction and variance increases, and the type of shock. In
particular, the last choice needs to reflect that an end-of-sample outlier may be a measurement error, or
an impulse, rather than a step shift.
Clements and Hendry (2001g) consider two strategies that employ pre-tests of parameter constancy.
In the first (Test1 ), at each forecast origin, either the purely model-based forecasts or the interceptcorrected forecasts based on whether or not a test on h 1-step forecasts up to the forecast origin is
significant is selected. If a break is signalled, a correction is applied based on the last l errors. The
second strategy retains information on all previous constancy rejections (Test2 ), and a dummy variable
is added for each forecast origin at which constancy was rejected. As doing so should improve in-sample
fit, the constancy test should be more likely to reject, in which case, a dummy is added for the last l
periods up to the forecast origin as with the other strategy.
They examine the performance of a four-lag VAR for output growth y and the spread S (between
1 year and 3 month Treasury Bill rates) from 1959:3 to 2001:1. Their first forecast origin is 1969:4 with
a maximum horizon of 8 quarters which generates 118 sequences of 1 to 8-step ahead forecasts. Figure
1 reports the MSFEs for S across the various strategies when l = 4 (similar results hold when l = 1).
The constant adjustment does much less well than an impulse; using a more stringent significance level
has little effect; it is slightly better to test than always correct; and Test1 is somewhat better than Test2 ,
18
but the difference is marginal. Never correcting is worse than always using an impulse, but much better
than a constant adjustment. A similar pattern was found for y, but with a more marked improvement
of Test1 over Test2 .
Impulse IC, 1% test
0.6
0.6
0.4
0.4
0.2
0.2
1
Test1
Test2
0.4
0.2
0.2
2
Figure 1
Test1
Test2
0.6
0.4
Always
Test1
Test2
0.6
Figure 2 records the rejection frequencies for three forms of Chow (1960) test on the constancy of
the VAR equation for S, and one system test, all scaled by their 5% 1-off critical values. As can be seen,
the forecast errors seem to be drawn from a 2-regime process, switching in 1982, after which it enters a
much more quiescent state. In the early period, outliers proliferate, hence the benefit of impulse over
constant adjustments, but after 1982 (the bulk of the evaluation sample) no breaks occur, which helps
explain the poor performance of always using a constant adjustment.
Investigation of the form the IC might take could prove useful. An example of a way of restricting the
ICs is suggested by Bewley (2000), who considers implementing ICs on the lines discussed in Clements
and Hendry (1999a), using an alternative parameterization of the deterministic terms in the VAR. We
note the advantages of the alternative parameterisation below, but note that he does not consider the
cointegrated case, where the corresponding re-parameterization is more awkward. The idea is to isolate
the long-run growth in the system, given by the vector , as the vector of intercepts, so that shifts in
growth rates are more easily discerned: a second advantage of is that zero restrictions can be placed on
specific elements of . For simplicity, consider an n-dimensional VAR in levels with a maximum lag of
p = 2:
(3)
xt = + A1 xt1 + A2 xt2 + t
where t INn [0, ]. In VEqCM form with r cointegrating vectors xt , (3) becomes:
xt = + xt1 + B1 xt1 + t
(4)
19
7.5
5.0
5.0
2.5
2.5
1970
1980
1990
7.5
2000
1970
1980
1990
2000
2.5
10
1.5
1.0
1980
Figure 2
1990
0.5
2000
1970
1980
1990
2000
where = (In B1 ) with E[xt ] = and E xt = when there are no breaks. Forecasts
of xt will approach linear time trends with slope as the horizon increases: thus, it is important to
accurately estimate . When = 0, Bewley (2000) sets to zero the elements of for variables that do
not exhibit drift, which can often be based on economic analysis (see Hendry and Doornik, 1997, for an
illustration). Such restrictions are non-linear in (5), and infeasible on in (3) or (4). However, applying
the Bewley (1979) transform to (4) delivers:
(6)
xt = + D xt1 + C0 2 xt + vt
where C0 = (I B1 )1 B1 , D = (I B1 )1 . Equivalent forecasts to (4) are obtained if, given a
super-consistent estimate of , (6) is estimated using xt1 as an instrument for 2 xt . Once = 0, so
the cointegration rank is non-zero, the relevant restrictions include = 0, not just i = 0. Moreover,
tests for deterministic shifts involve and , whereas only the combined intercept D is available.
A test focusing specifically on shifts in would be valuable.
7.2 Modelling shifts
Again from a real time perspective, Phillips (1994, 1996) proposes a formal procedure for re-selecting
and re-estimating a model as the sample changes.6 This amounts to a more substantial revision to the
equations than adjustments to the equations intercepts, and he finds improved forecasts.
Other authors have focused on the possibility of modelling intercept shifts using a variety of regimeswitching models. The idea behind the residual-based method of intercept corrections is that the structural change occurs close to the end of the sample but is unknown to the forecaster. However, in some
instances a time series may have exhibited a sudden change in mean over the sample period. For example, consider the time series depicted by Hamilton (1993), figures 24, pp.232234. Then a number of
6
20
possibilities arise, one of which is to include appropriate dummy variables (impulse or shift, depending
on whether the change is immediately reversed) to capture the effects of outliers or one-off factors,
without which the model may not be constant over the past. This strategy is popular in econometric
modeling: see, for example, Clements and Mizon (1991) . However, to the extent that these oneoff factors could not have been foreseen ex ante and may occur again, the model standard error is an
under-estimate of the true uncertainty inherent in explaining the dependent variable (1-step ahead), and
prediction intervals derived from the model may be similarly misleading. Thus, a more accurate picture
of the uncertainty surrounding the model predictions may be obtained by explicitly building into the
probabilistic structure of the model the possibility that further regime changes may occur. Hamilton
(1989) suggested using Markov switching regression (MSR) models in these circumstances, where the
temporal dependence in time series suggested the use of autoregressions (hence, MSAR), building on
the work of, e.g., Goldfeld and Quandt (1973). However, forecast confidence intervals (with a reasonably high nominal coverage level) even from models that omit this additional source of uncertainty are
often found to be alarmingly wide, so that a greater benefit would appear to be any reductions in bias
that might be achieved.
In this regard, consider the model:
yt (st ) = (yt1 (st1 )) + t ,
where t IN[0, 2 ], and the conditional mean (st ) switches between two states:
1 > 0 if st = 1 (expansion or boom),
(st ) =
2 < 0 if st = 2 (contraction or recession),
(7)
(8)
and the states st are determined by an ergodic Markov chain with transition probabilities:
pij = Pr(st+1 = j | st = i),
2
(9)
j=1
Clements and Krolzig (1998) show that the forecast function for this model can be written as:
T +h|T y = h yT y + (2 1 ) (p11 + p22 1)h h
y
T |T .
T |T is the filtered probability of being in regime 2
where y is the unconditional mean of yt , and
corrected for the unconditional probability. Thus, the conditional mean of yT +h equals the optimal
prediction rule for a linear model (the first term), plus the contribution of the Markov regime-switching
T |T contains the information about the
structure, which is given by the term multiplied by
T |T , where
most recent regime at the time the forecast is made. The contribution of the non-linear part to the overall
forecast also depends on the magnitude of the regime shifts, |2 1 |, and on the persistence of regime
shifts p11 + p22 1 relative to the persistence of the Gaussian process, given by . In their empirical
model of post War US GDP growth, the predictive power of detected regime shifts is extremely small,
p11 + p22 1 , so the conditional expectation collapses to a linear prediction rule. In general, then,
the persistence of regimes and the degree of precision with which the current regime can be determined
are important factors.
A number of other studies have reached fairly negative conclusions from a forecasting perspective
at least, there appears to be no clear consensus that allowing for non-linearities of these types leads
to an improved forecast performance (see, e.g., De Gooijer and Kumar, 1992). Clements and Smith
(2000b, 2000a) examine forecast performance from various non-linear specifications: see Granger and
21
Terasvirta (1993), and Franses and Van Dijk (2000) for more extensive discussions of forecasting with
non-linear models. Swanson and White (1997) consider a flexible specification of linear and non-linear
models where the latter is linked to shifts, and Koop and Potter (2000) seek to differentiate between nonlinearity, structural breaks, and outliers: Stock and Watson (1999a) conclude that non-linear models do
not substantively outperform linear.
New classes of model are almost certainly required, perhaps variants of the switching class proposed
by Engle and Smith (1998). Osborn, Sensier and Simpson (2001) claim that Markov switching models
with leading indicators to help predict the regime may fare better. The improvements result from being
better able to predict entry and exit to the rare event of recessions: see section 7.9. The simple algebra
above shows how this might help. However, as yet there does not seem to be a consensus on the
advantages of any given approach for DGPs with deterministic shifts.
7.3 Forecast smoothing
It is unclear whether forecasting agencies should regard accuracy as their dominant goal, relative to,
say, plausibility. When forecasts of the same outcome are made at different times, the implicit cost
function may penalize sharp changes between adjacent forecasts: Nordhaus (1987) presents evidence
that such inter-forecast smoothing occurs. Indeed, Don (2001) rejects the role of statistical criteria in
judging forecast quality, and favours logical and economic coherence, and stability. The third of
these entails smoothing the announced forecasts towards previous statements when changes in available
information entail more substantive revisions. Clements (1995) examined judgemental adjustments
introduced to reduce high frequency fluctuations in forecasts, but found no significant positive firstorder serial correlation in the revisions to fixed-event forecasts for either the judgemental or mechanical
forecasts from the Oxford Economic Forecasting model for the UK in the late 80s and early 90s. He
concluded that their forecasts were not excessively smooth in the Nordhaus (1987) sense, although ICs
reduced the dispersion of purely model-based forecasts. Further work in this area is reported in Clements
(1997) and Clements and Taylor (2001).
Analytical results are needed of the impact of smoothing behaviour by forecasting agencies on
the various sources of forecast error in section 3.1, not just when there are substantial white-noise
measurement errors. For example, smoothing is antithetical to using ICs based on the latest forecast
errors, and must induce delayed responses to deterministic shifts.
7.4 Role of surveys in forecasting
Survey information is possibly causal (in that the reported findings alter the behaviour of some economic
agents), but there does not seem much evidence on that. Consequently, we regard surveys as a noncausal input to the forecasting processes. Such information could be entered as a regressor in forecasting
systems, but that seems subject to the same problems as Emerson and Hendry (1996) found for leading
indicators (see section 7.10). Alternatively, surveys might inform the estimate of the variables at the
forecast origin (see section 7.6), perhaps guiding the choice of IC. Clements and Hendry (1998) suggest
using signal extraction across all the available measures of the forecast origin to obtain better estimates.
22
This paper was written before Hendry and Clements (2001g), who present formal explanations of why pooling will
outperform when deterministic shifts occur in mis-specified models, and confirm their analysis by empirical and simulation
illustrations.
23
Consider an h-step forecast from (3) when p = 1 commencing at a forecast origin at time T . Since:
xT+h =
h1
Ai1
Ah1 xT
i=0
h1
Ai1 T+hi
(10)
i=0
(11)
+
h xT ,
T +h =
x
h
rather than from estimating the parameters of (3) and using the analog of (10):
T +h =
x
h1
1
A
i
h
1 xT .
+ A
(12)
i=0
so:
h1
Ai1 = (In A1 )1 In Ah1 ,
Ai1 = (In A1 )1 In Ah1 = h .
i=0
It is difficult to see how multi-step estimation could offer more than minor gains in stationary processes.
Despite biased parameter estimates, the long-run mean E[xt ] = will be estimated consistently; and if
the error process has a symmetric distribution, the forecasts from (12) will be unbiased, even if both the
systematic and error dynamics are mis-specified.
However, when the process is non-stationary, intercepts partly represent drift terms, so misestimation could have more serious consequences. In the special case A1 = In , = from (5),
T+h :
so letting
T +h = xT+h x
h1
h
i
1
1
(13)
A
+ In E A
xT .
E [
T+h | xT ] = h E
i=0
1 (In )i In i,
1 = In approximating by E A
E A
= ), then neglecting
and similarly, the average error in
as an estimator of be (E
interactions and powers:
(h 1)
(h 1)
+
+ xT .
(14)
E [
T+h | xT ] h In
2
2
A term like (14) could become large as h increases, especially as under-estimating unit roots converts
from a drift term in an integrated process to an equilibrium mean in the resulting (pseudo-stationary)
estimated process. For example, an unmodelled negative moving-average error in (3) would induce
24
such an outcome: see Hall (1989). However, Clements and Hendry (1996b) find that serious misspecification of a mean-zero dynamic model is needed to ensure any gain from multi-step estimators
even in integrated processes: the simulation evidence in Bhansali (2001) matches theirs, even though
he also considers processes with non-zero means. Chevillon (2000) provides an analytic explanation
for such Monte Carlo results in a scalar process, and shows that (e.g.) the biases and MSFEs are not
monotonic functions of the DGP parameters or the horizon. He also considers DGPs with deterministic
shifts just prior to the forecast origin (within h periods), and suggests that multi-step estimation does
not ensure advantages in that setting either.
7.8 Co-breaking in forecasting
Co-breaking investigates whether shifts in deterministic terms in individual series cancel under linear
combinations (see Hendry, 1995, Hendry and Massmann, 2000, and Clements and Hendry, 1999a).
At first sight, a finding of co-breaking might seem invaluable for forecasting, since improved accuracy
for the co-breaking combinations must result. Unfortunately, in an ex ante context, some of the series
where the break itself occurs will still fail to be forecast well, so other combination will continue to
suffer forecast failure. Nevertheless, both for econometric modelling and for forecasting some important
variables, co-breaking seems likely to help.
As with cointegration, the feature which brings benefits is the existence of co-breaking, rather than
its imposition on a model, although the latter will help in efficiency terms, and perhaps understanding.
An estimation algorithm for conditional co-breaking (in a dynamic model) has been proposed by Krolzig
and Toro (2000); and for unconditional co-breaking (in the underlying process) by Massmann (2001),
whose Monte Carlo experiments suggest reasonable power properties for tests of co-breaking rank,
although the break points were assumed known a priori. An operational algorithm would have to jointly
diagnose breaks and find co-breaking vectors, along the lines of Johansen (1988).
7.9 Forecasting rare events
The analysis above has primarily been concerned with post-break corrections, where the specification
of the indicator variable to represent an intercept correction can be seen as determining the estimate of
the magnitude and timing of any putative break. Forecasts made before a break and in ignorance of its
impending occurrence are bound to suffer its full effects. Consequently, attempts to forecast future rare
events which entail deterministic shifts must be considered.
Environmental rare events such as hurricanes, earthquakes and volcano eruptions usually issue advance signs that are harbingers of impending problems. Recent advances in (say) earth sciences for
forecasting volcanic eruptions have focused on leading indicators (e.g., the temperature of the vented
steam, where rises indicate increased activity), so we reconsider that avenue in section 7.10. If economic counterparts have corresponding attributes, then a search for early-warning signals is merited.
As noted above, Osborn et al. (2001) treat recessions as sufficiently rare that leading indicators in a
regime-shift model might help in their prediction, and claim some success.
Unfortunately, many other rare events are not part of a sequence like business cycles on which
even a small sample of observations is available: examples include the 1984 Banking Act and the 1986
Building Societies Act in the UK. Even so, rare events should be partly predictable since they have
causes, and some of those causes may be discernible in advance. One route may be monitoring highfrequency data, which should reflect deterministic shifts much sooner in real time, although there is the
corresponding drawback that such data tend to be noisier. Nevertheless, early-warning signals merit
25
serious consideration, and we believe that high-frequency readings on the state of the economy must
play a role in this area.
7.10 Leading indicators
Emerson and Hendry (1996) found that in theory and practice composite leading indicators (CLIs) by
themselves were not likely to prove good at forecasting relative to robustified devices. Moreover, adding
a leading indicator to a VAR, as in Artis, Bladen-Hovell, Osborn, Smith and Zhang (1995), might even
jeopardize the latters robustness for little gain (but see Marsland and Weale, 1992). More recently,
Camba-Mendez, Kapetanios, Weale and Smith (2001) compare the performance of CLIs against a set
of benchmark VARs, but find that they are out-performed by naive predictors. They attribute this
outcome to the choice of leading indicators, and suggest improved measures can be found.
Another purpose of CLIs might be to forecast a possible deterministic shift. However, it is difficult
to see why present approaches to selecting such indicators would be optimal for that task, and recent
experience remains somewhat discouraging: see Stock and Watson (1989, 1993).
8 Conclusions
A theory of economic forecasting that allows for structural breaks and mis-specified models (inter alia)
has radically different implications from one that assumes stationarity and well-specified models. It can
be shown that theorems that can be readily established assuming stationarity and correct specification
do not carry over to the more realistic setting, where realistic denotes consonance with the empirical
evidence on forecast failure and from forecasting competitions. Proposals for improving forecasting need to be examined and judged within this setting. Doing so suggests ten areas where empirical
performance can be understood, and ten that deserve greater research. Moreover, there are important
implications from the revised theory about selecting models for forecasting and economic policy analysis.
References
Allen, P. G., and Fildes, R. A. (2001). Econometric forecasting strategies and techniques. In Armstrong,
J. S. (ed.) , Principles of Forecasting, pp. 303362. Boston: Kluwer Academic Publishers.
Artis, M. J., Bladen-Hovell, R. C., Osborn, D. R., Smith, G. W., and Zhang, W. (1995). Turning point
prediction in the UK using CSO leading indicators. Oxford Economic Papers, 47, 397417.
Barrell, R. (2001). Forecasting the world economy. In Hendry and Ericsson (2001), pp. 149169.
Bewley, R. (2000). Controlling spurious drift in macroeconomic forecasting models. mimeo, University
of New South Wales.
Bewley, R. A. (1979). The direct estimation of the equilibrium response in a linear model. Economics
Letters, 3, 357361.
Bhansali, R. J. (2001). Multi-step forecasting. In Clements and Hendry (2001a), pp. 206221.
Bollerslev, T., Engle, R. F., and Nelson, D. B. (1994). ARCH models. In Engle, R. F., and McFadden,
D. (eds.) , The Handbook of Econometrics, Volume 4, pp. 29593038: North-Holland.
Burns, T. (1986). The interpretation and use of economic predictions. Proceedings of the Royal Society,
A407, 103125.
26
Calzolari, G. (1981). A note on the variance of ex post forecasts in econometric models. Econometrica,
49, 15931596.
Camba-Mendez, G., Kapetanios, G., Weale, M. R., and Smith, R. J. (2001). The forecasting performance
of the OECD composite leading indicators for France, Germany, Italy and the UK. In Clements
and Hendry (2001a), pp. 386408.
Chevillon, G. (2000). Multi-step estimation for forecasting non-stationary processes. MPhil Thesis,
Economics Department, University of Oxford.
Chong, Y. Y., and Hendry, D. F. (1986). Econometric evaluation of linear macro-economic models.
Review of Economic Studies, 53, 671690. Reprinted in Granger, C. W. J. (ed.) (1990), Modelling
Economic Series. Oxford: Clarendon Press.
Chow, G. C. (1960). Tests of equality between sets of coefficients in two linear regressions. Econometrica, 28, 591605.
Christoffersen, P. F. (1998). Evaluating interval forecasts. International Economic Review, 39, 841862.
Chu, C.-S., Stinchcombe, M., and White, H. (1996). Monitoring structural change. Econometrica, 64,
10451065.
Clemen, R. T. (1989). Combining forecasts: A review and annotated bibliography. International Journal
of Forecasting, 5, 559583.
Clements, M. P. (1995). Rationality and the role of judgement in macroeconomic forecasting. Economic
Journal, 105, 410420.
Clements, M. P. (1997). Evaluating the rationality of fixed-event forecasts. Journal of Forecasting, 16,
225239.
Clements, M. P., and Hendry, D. F. (1993). On the limitations of comparing mean squared forecast
errors. Journal of Forecasting, 12, 617637. With discussion.
Clements, M. P., and Hendry, D. F. (1995). Forecasting in cointegrated systems. Journal of Applied
Econometrics, 10, 127146. Reprinted in T. C. Mills (ed.) Economic Forecasting. The International Library of Critical Writings in Economics, Edward Elgar.
Clements, M. P., and Hendry, D. F. (1996a). Intercept corrections and structural change. Journal of
Applied Econometrics, 11, 475494.
Clements, M. P., and Hendry, D. F. (1996b). Multi-step estimation for forecasting. Oxford Bulletin of
Economics and Statistics, 58, 657684.
Clements, M. P., and Hendry, D. F. (1997). An empirical study of seasonal unit roots in forecasting.
International Journal of Forecasting, 13, 341356.
Clements, M. P., and Hendry, D. F. (1998). Forecasting Economic Time Series. Cambridge: Cambridge
University Press.
Clements, M. P., and Hendry, D. F. (1999a). Forecasting Non-stationary Economic Time Series. Cambridge, Mass.: MIT Press.
Clements, M. P., and Hendry, D. F. (1999b). On winning forecasting competitions in economics. Spanish
Economic Review, 1, 123160.
Clements, M. P., and Hendry, D. F. (eds.) (2001a). A Companion to Economic Forecasting. Oxford:
Blackwells.
Clements, M. P., and Hendry, D. F. (2001b). Explaining forecast failure in macroeconomics. In Clements
and Hendry (2001a), pp. 539571.
27
Clements, M. P., and Hendry, D. F. (2001c). Explaining the results of the M3 forecasting competition.
International Journal of Forecasting, Forthcoming.
Clements, M. P., and Hendry, D. F. (2001d). Forecasting with difference-stationary and trend-stationary
models. Econometrics Journal, 4, S1S19.
Clements, M. P., and Hendry, D. F. (2001e). An historical perspective on forecast errors. National
Institute Economic Review, 177, 100112.
Clements, M. P., and Hendry, D. F. (2001f). Modelling methodology and forecast failure. Econometrics
Journal, forthcoming.
Clements, M. P., and Hendry, D. F. (2001g). Structural change and economic forecasting. Unpublished
typescript, Economics Department, University of Oxford.
Clements, M. P., and Krolzig, H.-M. (1998). A comparison of the forecast performance of Markovswitching and threshold autoregressive models of US GNP. Econometrics Journal, 1, C4775.
Clements, M. P., and Mizon, G. E. (1991). Empirical analysis of macroeconomic time series: VAR and
structural models. European Economic Review, 35, 887932.
Clements, M. P., and Smith, J. (2000a). Evaluating forecasts from SETAR models of exchange rates.
Journal of International Money and Finance, 20, 133148.
Clements, M. P., and Smith, J. (2000b). Evaluating the forecast densities of linear and non-linear models:
Applications to output growth and unemployment. Journal of Forecasting, 19, 255276.
Clements, M. P., and Taylor, N. (2000). Evaluating prediction intervals for high-frequency data. mimeo,
Department of Economics, University of Warwick.
Clements, M. P., and Taylor, N. (2001). Robust evaluation of fixed-event forecast rationality. Journal of
Forecasting, 20, 285295.
Cooper, J. P., and Nelson, C. R. (1975). The ex ante prediction performance of the St. Louis and FRBMIT-PENN econometric models and some results on composite predictors. Journal of Money,
Credit, and Banking, 7, 132.
De Gooijer, J. G., and Kumar, K. (1992). Some recent developments in non-linear time series modelling,
testing and forecasting. International Journal of Forecasting, 8, 135156.
Dhrymes, P. J., et al. (1972). Criteria for evaluation of econometric models. Annals of Economic and
Social Measurement, 1, 291324.
Diebold, F. X. (1998). The past, present and future of macroeconomic forecasting. The Journal of
Economic Perspectives, 12, 175192.
Diebold, F. X., Gunther, T. A., and Tay, A. S. (1998). Evaluating density forecasts: With applications to
financial risk management. International Economic Review, 39, 863883.
Don, F. J. H. (2001). Forecasting in macroeconomics: A practitioners view. De Economist, 149,
155175.
Eitrheim, ., Huseb, T. A., and Nymoen, R. (1999). Equilibrium-correction versus differencing in
macroeconometric forecasting. Economic Modelling, 16, 515544.
Emerson, R. A., and Hendry, D. F. (1996). An evaluation of forecasting using leading indicators. Journal
of Forecasting, 15, 271291.
Engle, R. F. (1982). Autoregressive conditional heteroscedasticity, with estimates of the variance of
United Kingdom inflation. Econometrica, 50, 9871007.
Engle, R. F., and Smith, A. D. (1998). Stochastic permanent breaks. Review of Economics and Statistics,
81, 553574.
28
Ericsson, N. R. (2001). Forecast uncertainty in economic modeling. In Hendry and Ericsson (2001),
pp. 6892.
Ericsson, N. R., and Irons, J. S. (1995). The Lucas critique in practice: Theory without measurement.
In Hoover, K. D. (ed.) , Macroeconometrics: Developments, Tensions and Prospects. Dordrecht:
Kluwer Academic Press.
Fildes, R., and Ord, K. (2001). Forecasting competitions their role in improving forecasting practice
and research. In Clements and Hendry (2001a), pp. 322253.
Fildes, R. A., and Makridakis, S. (1995). The impact of empirical accuracy studies on time series
analysis and forecasting. International Statistical Review, 63, 289308.
Franses, P. H., and Van Dijk, D. (2000). Non-linear Time Series Models in Empirical Finance. Cambridge: Cambridge University Press.
Goldfeld, S. M., and Quandt, R. E. (1973). A Markov model for switching regressions. Journal of
Econometrics, 1, 316.
Granger, C. W. J. (2001). Evaluation of forecasts. In Hendry and Ericsson (2001), pp. 93103.
Granger, C. W. J., and Pesaran, M. H. (2000a). A decision-theoretic approach to forecast evaluation. In
Chon, W. S., Li, W. K., and Tong, H. (eds.) , Statistics and Finance: An Interface, pp. 261278.
London: Imperial College Press.
Granger, C. W. J., and Pesaran, M. H. (2000b). Economic and statistical measures of forecasting accuracy. Journal of Forecasting, 19, 537560.
Granger, C. W. J., and Terasvirta, T. (1993). Modelling Nonlinear Economic Relationships. Oxford:
Oxford University Press.
Granger, C. W. J., White, H., and Kamstra, M. (1989). Interval forecasting: An analysis based upon
ARCH-quantile estimators. Journal of Econometrics, 40, 8796.
Hall, A. (1989). Testing for a unit root in the presence of moving average errors. Biometrika, 76, 4956.
Hamilton, J. D. (1989). A new approach to the economic analysis of nonstationary time series and the
business cycle. Econometrica, 57, 357384.
Hamilton, J. D. (1993). Estimation, inference, and forecasting of time series subject to changes in
regime. In Maddala, G. S., Rao, C. R., and Vinod, H. D. (eds.) , Handbook of Statistics, Vol. 11:
Amsterdam: NorthHolland.
Hansen, B. E. (2001). The new econometrics of structural change: Understanding and dating changes
in US productivity. mimeo, Department of Economics, University of Wisconsin.
Hansen, H., and Johansen, S. (1998). Some tests for parameter constancy in cointegrated VAR-models.
Mimeo, Economics Department, European University Institute.
Hatch, N. (2001). Modelling and forecasting at the Bank of England. In Hendry and Ericsson (2001),
pp. 124148.
Hendry, D. F. (1995). A theory of co-breaking. Mimeo, Nuffield College, University of Oxford.
Hendry, D. F. (2000a). A general forecast-error taxonomy. Mimeo, Nuffield College, Oxford.
Hendry, D. F. (2000b). On detectable and non-detectable structural change. Structural Change and
Economic Dynamics, 11, 4565.
Hendry, D. F. (2001). How economists forecast. In Hendry and Ericsson (2001), pp. 1541.
Hendry, D. F. , and Clements, M. P. (2001g). Pooling of forecasts. Unpublished typescript, Economics
Department, University of Oxford.
29
Hendry, D. F., and Doornik, J. A. (1997). The implications for econometric modelling of forecast failure.
Scottish Journal of Political Economy, 44, 437461. Special Issue.
Hendry, D. F., and Ericsson, N. R. (eds.) (2001). Understanding Economic Forecasts. Cambridge,
Mass.: MIT Press.
Hendry, D. F., and Juselius, K. (2000). Explaining cointegration analysis: Part I. Energy Journal, 21,
142.
Hendry, D. F., and Juselius, K. (2001). Explaining cointegration analysis: Part II. Energy Journal, 22,
75120.
Hendry, D. F., and Massmann, M. (2000). Macro-econometric forecasting and co-breaking. Mimeo,
Economics Department, Oxford University.
Hendry, D. F., and Mizon, G. E. (2000a). On selecting policy analysis models by forecast accuracy. In
Atkinson, A. B., Glennerster, H., and Stern, N. (eds.) , Putting Economics to Work: Volume in
Honour of Michio Morishima, pp. 71113. London School of Economics: STICERD.
Hendry, D. F., and Mizon, G. E. (2000b). Reformulating empirical macro-econometric modelling.
Oxford Review of Economic Policy, 16, 138159.
Hillmer, S. (1984). Monitoring and adjusting forecasts in the presence of additive outliers. Journal of
Forecasting, 3, 205215.
Hoogstrate, A. J., Palm, F. C., and Pfann, G. A. (1996). To pool or not to pool: Forecasting international
output growth rates. Research Memorandum 96/025, Meteor, University of Limburg, Maastricht.
Johansen, S. (1988). Statistical analysis of cointegration vectors. Journal of Economic Dynamics and
Control, 12, 231254. Reprinted in R.F. Engle and C.W.J. Granger (eds), Long-Run Economic
Relationships, Oxford: Oxford University Press, 1991, 13152.
Johansen, S., Mosconi, R., and Nielsen, B. (2000). Cointegration analysis in the presence of structural
breaks in the deterministic trend. Journal of Econometrics, forthcoming.
Judge, G. G., and Bock, M. E. (1978). The Statistical Implications of Pre-Test and Stein-Rule Estimators
in Econometrics. Amsterdam: North Holland Publishing Company.
Kennedy, P. E. (2001). Sinning in the basement: What are the rules? The Ten Commandments of
applied econometrics. Mimeo, Economics Department, Simon Fraser University.
Kim, S., Shephard, N., and Chib, S. (1998). Stochastic volatility: likelihood inference and comparison
with ARCH models. Review of Economic Studies, 65, 361393.
Klein, L. R. (1971). An Essay on the Theory of Economic Prediction. Chicago: Markham Publishing
Company.
Koop, G., and Potter, S. M. (2000). Nonlinearity, structural breaks, or outliers in economic time series.
In Barnett, W. A., Hendry, D. F., Hylleberg, S., Terasvirta, T., Tjostheim, D., and Wurtz, A. (eds.)
Nonlinear Econometric Modeling in Time Series Analysis, pp. 6178. Cambridge: Cambridge
University Press.
Krolzig, H.-M., and Toro, J. (2000). Testing for cobreaking and superexogeneity in the presence of
deterministic shifts. Economics discussion paper 2000-W35, Nuffield College, Oxford.
Lu, M., and Mizon, G. E. (1991). Forecast encompassing and model evaluation. In Hackl, P., and
Westlund, A. H. (eds.) , Economic Structural Change, Analysis and Forecasting, pp. 123138.
Berlin: Springer-Verlag.
Lucas, R. E. (1976). Econometric policy evaluation: A critique. In Brunner, K., and Meltzer, A. (eds.),
The Phillips Curve and Labor Markets,Vol.1ofCarnegie-Rochester Conferences on Public
Policy, pp. 1946. Amsterdam: North-Holland Publishing Company.
30
Makridakis, S., Andersen, A., Carbone, R., Fildes, R., et al. (1982). The accuracy of extrapolation (time
series) methods: Results of a forecasting competition. Journal of Forecasting, 1, 111153.
Makridakis, S., and Hibon, M. (2000). The M3-competition: Results, conclusions and implications.
International Journal of Forecasting, 16, 451476.
Marsland, J., and Weale, M. (1992). The leading indicator in a VAR model of the UK. Unpublished
paper, Downing College and Clare College, University of Cambridge.
Massmann, M. (2001). Co-breaking in macroeconomic time series. Unpublished paper, Economics
Department, Oxford University.
McNees, S. K. (1990). The accuracy of macroeconomic forecasts. In Klein, P. A. (ed.) , Analyzing
Modern Business Cycles, pp. 143173. London: M. E. Sharpe Inc.
Mincer, J., and Zarnowitz, V. (1969). The evaluation of economic forecasts. In Mincer, J. (ed.) ,
Economic Forecasts and Expectations. New York: National Bureau of Economic Research.
Newbold, P. (1993). Comment on On the limitations of comparing mean squared forecast errors, by
M.P. Clements and D.F. Hendry. Journal of Forecasting, 12, 658660.
Nordhaus, W. D. (1987). Forecasting efficiency: Concepts and applications. Review of Economics and
Statistics, 69, 667674.
Osborn, D. (2001). Unit root versus deterministic representations of seasonality for forecasting. In
Clements and Hendry (2001a), pp. 409431.
Osborn, D. R., Sensier, M., and Simpson, P. W. (2001). Forecasting and the UK business cycle. In
Hendry and Ericsson (2001), pp. 104123.
Pesaran, M. H., and Skouras, S. (2001). Decision-based methods for forecast evaluation. In Clements
and Hendry (2001a), pp. 241267.
Phillips, P. C. B. (1994). Bayes models and forecasts of Australian macroeconomic time series. In
Hargreaves, C. (ed.) , Non-stationary Time-series Analysis and Cointegration, pp. 5386. Oxford:
Oxford University Press.
Phillips, P. C. B. (1996). Econometric model determination. Econometrica, 64, 763812.
Richard, J.-F., and Zhang, W. (1996). Econometric modelling of UK house prices using accelerated
importance sampling. Oxford Bulletin of Economics and Statistics, 58, 601613.
Sampson, M. (1991). The effect of parameter uncertainty on forecast variances and confidence intervals
for unit root and trend stationary time-series models. Journal of Applied Econometrics, 6, 6776.
Singer, M. (1997). Thoughts of a nonmillenarian. Bulletin of the American Academy of Arts and
Sciences, 51(2), 3651.
Stock, J. H. (1996). VAR, error correction and pre-test forecasts at long horizons. Oxford Bulletin of
Economics and Statistics, 58, 685701.
Stock, J. H., and Watson, M. W. (1989). New indexes of coincident and leading economic indicators.
NBER Macro-Economic Annual, 351409.
Stock, J. H., and Watson, M. W. (1993). A procedure for predicting recessions with leading indicators:
Econometric issues and recent experience. In Stock, J. H., and Watson, M. W. (eds.) , Business
Cycles, Indicators and Forecasting, pp. 95156: Chicago: University of Chicago Press.
Stock, J. H., and Watson, M. W. (1996). Evidence on structural instability in macroeconomic time series
relations. Journal of Business and Economic Statistics, 14, 1130.
31
Stock, J. H., and Watson, M. W. (1999a). A comparison of linear and nonlinear models for forecasting
macroeconomic time series. In Engle, R. F., and White, H. (eds.) , Cointegration, Causality and
Forecasting, pp. 144. Oxford: Oxford University Press.
Swanson, N. R., and White, H. (1997). Forecasting economic time series using flexible versus fixed
specification and linear versus nonlinear econometric models. International Journal of Forecasting, 13, 439462.
Tay, A. S., and Wallis, K. F. (2001). Density forecasting: A survey. Mimeo, Department of Economics,
University of Warwick, UK. Forthcoming in M. P. Clements and D. F. Hendry (eds), A Companion
to Economic Forecasting, (2001), Blackwells.
Theil, H. (1966). Applied Economic Forecasting. Amsterdam: North-Holland.
Turner, D. S. (1990). The role of judgement in macroeconomic forecasting. Journal of Forecasting, 9,
315345.
Wallis, K. F. (1986). Forecasting with an econometric model: The ragged edge problem. Journal of
Forecasting, 5, 114.
Wallis, K. F. (1989). Macroeconomic forecasting: A survey. Economic Journal, 99, 2861.
Wallis, K. F., and Whitley, J. D. (1991). Sources of error in forecasts and expectations: UK economic
models, 19841988. Journal of Forecasting, 10, 231253.
32
33
34
38 The optimal inflation tax when taxes are costly to collect by F. De Fiore, November 2000.
39 A money demand system for euro area M3 by C. Brand and N. Cassola, November 2000.
40 Financial structure and the interest rate channel of ECB monetary policy by B. Mojon,
November 2000.
41 Why adopt transparency? The publication of central bank forecasts by P. M. Geraats,
January 2001.
42 An area-wide model (AWM) for the euro area by G. Fagan, J. Henry and R. Mestre,
January 2001.
43 Sources of economic renewal: from the traditional firm to the knowledge firm
by D. R. Palenzuela, February 2001.
44 The supply and demand for eurosystem deposits The first 18 months by U. Bindseil and
F. Seitz, February 2001.
45 Testing the Rank of the Hankel matrix: a statistical approach by G. Camba-Mendez and
G. Kapetanios, February 2001.
46 A two-factor model of the German term structure of interest rates by N. Cassola and
J. B. Lus, February 2001.
47 Deposit insurance and moral hazard: does the counterfactual matter? by R. Gropp and
J. Vesala, February 2001.
48 Financial market integration in Europe: on the effects of EMU on stock markets by
M. Fratzscher, March 2001.
49 Business cycle and monetary policy analysis in a structural sticky-price model of the euro
area by M. Casares, March 2001.
50 Employment and productivity growth in service and manufacturing sectors in France,
Germany and the US by T. von Wachter, March 2001.
51 The functional form of the demand for euro area M1 by L. Stracca, March 2001.
52 Are the effects of monetary policy in the euro area greater in recessions than in booms? by
G. Peersman and F. Smets, March 2001.
53 An evaluation of some measures of core inflation for the euro area by J.-L. Vega and
M. A. Wynne, April 2001.
54 Assessment criteria for output gap estimates by G. Camba-Mndez and D. R. Palenzuela,
April 2001.
55 Modelling the demand for loans to the private sector in the euro area by A. Calza,
G. Gartner and J. Sousa, April 2001.
35
56 Stabilization policy in a two country model and the role of financial frictions by E. Faia,
April 2001.
57 Model-based indicators of labour market rigidity by S. Fabiani and D. Rodriguez-Palenzuela,
April 2001.
58 Business cycle asymmetries in stock returns: evidence from higher order moments and
conditional densities by G. Perez-Quiros and A. Timmermann, April 2001.
59 Uncertain potential output: implications for monetary policy by M. Ehrmann and F. Smets,
April 2001.
60 A multi-country trend indicator for euro area inflation: computation and properties by
E. Angelini, J. Henry and R. Mestre, April 2001.
61 Diffusion index-based inflation forecasts for the euro area by E. Angelini, J. Henry and
R. Mestre, April 2001.
62 Spectral based methods to identify common trends and common cycles by G. C. Mendez
and G. Kapetanios, April 2001.
63 Does money lead inflation in the euro area? by S. N. Altimari, May 2001.
64 Exchange rate volatility and euro area imports by R. Anderton and F. Skudelny, May 2001.
65 A system approach for measuring the euro area NAIRU by S. Fabiani and R. Mestre,
May 2001.
66 Can short-term foreign exchange volatility be predicted by the Global Hazard Index? by
V. Brousseau and F. Scacciavillani, June 2001.
67 The daily market for funds in Europe: Has something changed with the EMU? by
G. P. Quiros and H. R. Mendizabal, June 2001.
68 The performance of forecast-based monetary policy rules under model uncertainty by
A. Levin, V. Wieland and J. C.Williams, July 2001.
69 The ECB monetary policy strategy and the money market by V. Gaspar, G. Perez-Quiros
and J. Sicilia, July 2001.
70 Central Bank forecasts of liquidity factors: Quality, publication and the control of the
overnight rate by U. Bindseil, July 2001.
71 Asset market linkages in crisis periods by P. Hartmann, S. Straetmans and C. G. de Vries,
July 2001.
72 Bank concentration and retail interest rates by S. Corvoisier and R. Gropp, July 2001.
73 Interbank lending and monetary policy transmission evidence for Germany by
M. Ehrmann and A. Worms, July 2001.
36
37