DP3146 Do Financial Variables Help Forecasting Inflation and Real Activity in the Euro Area?

Author(s): Mario Forni, Marc Hallin, Marco Lippi, Lucrezia Reichlin
Publication Date: January 2002
Keyword(s): business cycle, dynamic factor models, financial variables, forecasting, principal componants
JEL(s): C13, C33, C43
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3146

The Paper uses a large data set, consisting of 447 monthly macroeconomic time series concerning the main countries of the Euro area to simulate out-of-sample predictions of the Euro area industrial production and the harmonized inflation index and to evaluate the role of financial variables in forecasting. We considered two models which allow forecasting based on large panels of time series: Forni, Hallin, Lippi, and Reichlin (2000, 2001c) and Stock and Watson (1999). Performance of both models was compared to that of a simple univariate AR model. Results show that multivariate methods outperform univariate methods for forecasting inflation at one, three, six, and twelve months and industrial production at one and three months. We find that financial variables do help forecasting inflation, but do not help forecasting industrial production.