DP86 On Evaluating the Importance of Non-Linearity in Large Macroeconometric Models

Author(s): Paul Fisher, Mark Salmon
Publication Date: December 1985
Keyword(s): Large Macro-Econometric Models, Non-Linearity, Stochastic Simulation
JEL(s): 211, 212
Programme Areas: Applied Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=86

Most model builders continue to treat their models as deterministic when forecasting, despite the fact that these models are composed of equations which are stochastic in nature. Deterministic solution methods ignore the stochastic information on the model structure and in addition produce biased forecasts in non-linear models. It is therefore important to investigate whether a given model is significantly non-linear. After commenting on the poor simulation methodology employed in a number of earlier studies, we find significant non-linear effects in two large macro models of the United Kingdom economy. This is confirmed by two tests that we propose for assessing the importance of non-linearity in such models.