Norges Bank

Working Paper

Error-correction versus differencing in macroeconometric forecasting

Author:
Øyvind Eitrheim, Tore Anders Husebø og Ragnar Nymoen
Series:
Working Paper
Number:
6/1998

Abstract:

Recent work by Clements and Hendry has shown why forecasting systems that are in terms of differences, dVARs, can be more accurate than econometric models that include levels variables, ECMs. For example, dVAR forecasts are insulated from parameter non-constancies in the long run mean of the cointegration relationships. In this paper, the practical relevance of these issues is investigated for RIMINI, the quarterly macroeconometric model used in Norges Bank, which we take as an example of an ECM forecasting model. We develop two dVAR forecasts for the period 1992.1-1994.4. In addition, we compare forecasts from the full scale models with those of univariate dVAR type models. The results seem to confirm the relevance of several important theoretical insights. dVAR forecasts appear to provide some immunity against parameter non-constancies that could seriously bias the ECM forecasts. On the other hand, for open systems like the RIMINI model, the misspecification resulting from omitting levels information seems to generate substantial biases in the dVAR forecasts. Therefore, the incumbent ECM performs comparatively well over the forecast period investigated in this paper.

Norges Bank’s working papers present research projects and reports that are generally not in their final form. Other analyses by Norges Bank’s economists are also included in the series. The views and conclusions in these documents are those of the authors.

Norges Bank’s Working Papers are also distributed by RepEcSSRN and BIS Central Bank Research Hub.

ISSN 1502-8190 (online)

Published 4 April 1998 12:11
Published 4 April 1998 12:11