A Small BVAR-DSGE Model for Forecasting the Australian Economy

This paper estimates a small structural model of the Australian economy, designed principally for forecasting the key macroeconomic variables of output growth, underlying inflation and the cash rate. In contrast to models with purely statistical foundations, which are often used for forecasting, the Bayesian Vector Autoregressive Dynamic Stochastic General Equilibrium (BVAR-DSGE) model uses the theoretical information of a DSGE model to offset in-sample over-fitting. We follow the method of Del Negro and Schorfheide (2004) and use a variant of the small open economy DSGE model of Lubik and Schorfheide (2007) to provide prior information for the VAR. The forecasting performance of the model is competitive with benchmark models such as a Minnesota VAR and an independently estimated DSGE model.