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Forecasting US inflation using Markov dimension switching

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  • Prüser, Jan

Abstract

This study considers Bayesian variable selection in the Phillips curve context by using the Bernoulli approach of Korobilis (2013a). The Bernoulli model, however, is unable to account for model change over time, which is important if the set of relevant predictors changes over time. To tackle this problem, this paper extends the Bernoulli model by introducing a novel modeling approach called Markov Dimension Switching (MDS). MDS allows the set of predictors to change over time. The MDS and Bernoulli model reveal that the unemployment rate, the Treasury bill rate and the number of newly built houses are the most important variables in the generalized Phillips curve. Furthermore, these three predictors exhibit a sizeable degree of time variation for which the Bernoulli approach is not able to account, stressing the importance and benefit of the MDS approach. In a forecasting exercise the MDS model compares favorably to the Bernoulli model for one quarter and one year ahead inflation. In addition, it turns out that the performance of MDS model forecasting is competitive in comparison with other models found to be useful in the inflation forecasting literature.

Suggested Citation

  • Prüser, Jan, 2017. "Forecasting US inflation using Markov dimension switching," Ruhr Economic Papers 710, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    • Handle: RePEc:zbw:rwirep:710
    DOI: 10.4419/86788828
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    References listed on IDEAS

    as
    1. Korobilis, Dimitris, 2013. "Hierarchical shrinkage priors for dynamic regressions with many predictors," International Journal of Forecasting, Elsevier, vol. 29(1), pages 43-59.
    2. Dimitris Korobilis, 2013. "Var Forecasting Using Bayesian Variable Selection," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 28(2), pages 204-230, March.
    3. Gary Koop & Dimitris Korobilis, 2012. "Forecasting Inflation Using Dynamic Model Averaging," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 53(3), pages 867-886, August.
    4. Joshua C.C. Chan & Gary Koop & Roberto Leon-Gonzalez & Rodney W. Strachan, 2012. "Time Varying Dimension Models," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 30(3), pages 358-367, January.
    5. Miguel A.G. Belmonte & Gary Koop & Dimitris Korobilis, 2014. "Hierarchical Shrinkage in Time‐Varying Parameter Models," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 33(1), pages 80-94, January.
    6. Sangjoon Kim & Neil Shephard & Siddhartha Chib, 1998. "Stochastic Volatility: Likelihood Inference and Comparison with ARCH Models," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 65(3), pages 361-393.
    7. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
    8. Ang, Andrew & Bekaert, Geert & Wei, Min, 2007. "Do macro variables, asset markets, or surveys forecast inflation better?," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1163-1212, May.
    9. Park, Trevor & Casella, George, 2008. "The Bayesian Lasso," Journal of the American Statistical Association, American Statistical Association, vol. 103, pages 681-686, June.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Phillips Curve; fat data; variable selection; model change;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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