The DELPHI model (Dynamic Econometric Large-scale Prognosticator of Hungarian Inflation)

The National Bank of Hungary (NBH) launched a project in 2008 that aimed to assembly a large scale econometric model incorporating all the relevant macroeconomic variables and encompassing large variety of transmission channels of Hungarian economy. The ultimate objective of this project was to base the regular forecasting and policy simulation activities of the NBH on to this model. In order to meet this objective the DELPHI model was designed so that it should be compatible with the previous studies carried out and the knowledge about Hungarian economy accumulated at the NBH.The model is a small open economy model on quarterly frequency. The model has more than 150 equations; most of them are identities and only 38 are behavioral equations. The model equations are written in error correction form. The long run equilibrium is determined by a neoclassical balance growth path. In short run, nominal and real frictions slow down the adjustment toward the equilibrium growth path. The DELPHI model ensures full stock-flow identity and merges the national account data and government’s financial account consistently. The DELPHI model has a well defined neoclassical long run equilibrium balance growth path with reasonable steady-state ratios for all the stock and flow variables. The supply side of the economy is described as follows. The value added is produced in private and government sectors. The private output is pinned down by a production function using capital and labor as input factors and technology level in the long run. The labor supply is exogenous in the long run, determined by demography and the NAIRU. The profit maximization principle of the firm determines the equilibrium amount of capital and investment. The output of the government sector is a function of the government’s capital and expenditures on wage bill. The demand side of the economy is affected by the following factors. Household’s consumption is a function of income, net financial wealth and net credit flow. Government consumption is determined by an accounting identity among government financial account. Corporate investment is pinned down by the firms’ profit maximization principle. Housing and government investment is affected by proper income. Export is driven by external demand and real exchange rate. Import is function of consumption, investment, export and real exchange rate. Consumer price inflation adjusts to its costs (unit labor cost, exchange rate, foreign prices, oil price) in the long run, however, in the short run it is affected by expectation and output gap (Phillips-curve). Wages in private sector are equal to their marginal product in the long run, but they are affected by expectation and conjuncture in the short run. Parameters determining steady ratios and growth rates along the balance growth path are calibrated; the short run adjustment processes are estimated on Hungarian seasonally adjusted national account data for period 1995Q1-2010Q3. The DELPHI model is able to describe the main driving force of the evolution of Hungarian economy. It contains some country specific transmission channel as well. For example balance sheet channel of the households due to their large foreign currency denominated mortgage debt is included in the model. The DELPHI model forecasts for main macro variables like inflation or GDP proved to be reliable especially on longer horizon (i.e. beyond 1 year) resulting smaller forecast errors compared to that of NBH’s published quarterly forecasts had in the past decade. Since 2010, DELPHI model has become the working horse model of the NBH, as well as the forecasts published in the NBH’s quarterly inflation report are based on this model. Regarding its central role in the NBH’s forecasts and policy simulation exercises, a complete data updating and reporting systems are built around the DELPHI model.