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Fundamentals versus the leading index-the forecasting of Canada's output growth since 1991: an encompassing approach

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  • Akhter Faroque
  • William Veloce

Abstract

We evaluate the ability of Statistics Canada's Composite Leading Index to forecast Canada's real Gross Domestic Product (GDP) growth rate in the backdrop of the Duguay (1994, JME) model and also the dynamic and the error-correction variants of the Duguay model, that already include the 'fundamentals' of the Canadian business cycle. The results show that integrating the index in these models substantially improve the in-sample fit of the models and also provide an explanation for the 'perplexingly' large influence of the US real GDP on aggregate spending in the Canadian economy. Out-of-sample forecasts over the inflation-targeting regime (January 1991-April 2004), evaluated using the forecast encompassing tests, confirm that the index contains an important amount of new information about the future growth rate, quite apart from the information contained in the fundamentals.

Suggested Citation

  • Akhter Faroque & William Veloce, 2010. "Fundamentals versus the leading index-the forecasting of Canada's output growth since 1991: an encompassing approach," Applied Economics, Taylor & Francis Journals, vol. 42(10), pages 1227-1243.
    • Handle: RePEc:taf:applec:v:42:y:2010:i:10:p:1227-1243
    DOI: 10.1080/00036840701721364
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    References listed on IDEAS

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    1. Yi Zheng & James Rossiter, 2006. "Using Monthly Indicators to Predict Quarterly GDP," Staff Working Papers 06-26, Bank of Canada.
    2. Victor Zarnowitz & Phillip Braun, 1989. "Major Macroeconomic Variables and Leading Indexes: Some Estimates of Their Interrelations, 1886-1982," NBER Working Papers 2812, National Bureau of Economic Research, Inc.
    3. Alexandre Debs, 2001. "Testing for a Structural Break in the Volatility of Real GDP Growth in Canada," Staff Working Papers 01-9, Bank of Canada.
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