Forecasting Macroeconomic Variables for the Acceding Countries

The accession of ten countries into the European Union makes the forecasting of their key macroeconomic indicators such as GDP growth, inflation and interest rates an exercise of some importance. Because of the transition period, only short spans of reliable time series are available which suggests the adoption of simple time series models as forecasting tools, because of their parsimonious specification and good performance. Nevertheless, despite this constraint on the span of data, a large number of macroeconomic variables (for a given time span) are available which are of potential use in forecasting, making the class of dynamic factor models a reasonable alternative forecasting tool. We compare the relative performance of the two forecasting approaches, first by means of simulation experiments and then by using data for five Acceding countries. We also evaluate the role of Euro-area information for forecasting, and the usefulness of robustifying techniques such as intercept corrections and second differencing. We find that factor models work well in general, even though there are marked differences across countries. Robustifying techniques are useful in a few cases, while Euro-area information is virtually irrelevant