A Bayesian Vector Autoregressive Model with Informative Steady‐state Priors for the Australian Economy

This article applies a Bayesian vector autoregressive model with informative steady‐state priors to a parsimonious model of the Australian economy. The model captures economic linkages among key Australian and US variables and is estimated on quarterly data from 1985 to 2006. An out‐of‐sample forecast exercise shows that the model with informative steady‐state priors generally outperforms a traditional Bayesian vector autoregressive model as well as naïve forecasts. The model can also be used to generate density forecasts and analyse alternative scenarios, which we illustrate with the effect on the Australian economy of a substantial real depreciation of the US dollar.