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A two-step dynamic factor modelling approach for forecasting inflation in small open economies

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  • Aysun, Uluc
  • Wright, Cardel

Abstract

We build a dynamic factor model to forecast inflation in a small open economy. The model is estimated with both market and survey data, and a unique two-step methodology to incorporate exogenous factors. Estimations with market data provide a better fit for in-sample and out-of-sample values of inflation. More importantly, our model outperforms univariate and estimated DSGE models, the more common approaches to inflation forecasting that perform well for advanced economies. Our findings, therefore, suggest that a dynamic factor modelling approach for a small open economy such as Jamaica can be a good alternative to the preferred methods for forecasting inflation in advanced economies.

Suggested Citation

  • Aysun, Uluc & Wright, Cardel, 2024. "A two-step dynamic factor modelling approach for forecasting inflation in small open economies," Emerging Markets Review, Elsevier, vol. 62(C).
    • Handle: RePEc:eee:ememar:v:62:y:2024:i:c:s1566014124000839
    DOI: 10.1016/j.ememar.2024.101188
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    More about this item

    Keywords

    Jamaica; Inflation expectations; Forecasting; Dynamic factor model; Survey data;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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