No. 14/2012: Forecast robustness in macroeconometric models

Abstract

The paper investigates explanations for forecasting invariance to structural breaks. After highlighting the role of policy, we isolate possible structural invariance in a simplified dynamic macro model that nevertheless has features in common with the standard model of aggregate demand and aggregate supply. We find, as expected, that structural breaks in growth rates and in the means of cointegrating relationships will always damage some of the variables. But we also find examples of "insulation" from shocks. The results about partial robustness is a property of the economy itself (here represented by the DGP) and not of the forecasts. "A trend is a trend, is a trend, but the question is, will it bend? Will it alter its course, through some unforeseen force and come to a premature end?"Sir Alec Cairncross