DP 2018 / 04 Real-time forecasting with macro-finance models in the presence of a zero lower bound

We investigate the forecasting performance of a joint model of macroeconomic and yield curve components for the United States, using data as would have been available in real time. Relative to a standard macroeconomic model benchmark, our results show a clear benefit from including yield curve information when forecasting inflation and the Federal Funds Rate, for horizons up to the four years that we tested. We find some real-time forecast improvement for capacity utilization, our variable representing real economic activity, but only for longer horizons, and similarly when using macroeconomic data to help forecast yield curve components. Using a shadow/lower-bound term structure model allows the ready extension of our forecasting framework to include the unconventional period of monetary policy, and we obtain very similar results to those already mentioned for the conventional period. ∗ The Reserve Bank of New Zealand’s discussion paper series is externally refereed. The views expressed in this paper are those of the author(s) and do not necessarily reflect the views of the Reserve Bank of New Zealand. We would like to thank participants at the 2015 New Zealand Econometrics Study Group, the 2015 New Zealand Association of Economists conference, Glen Rudebusch, Ken West, and colleagues at the Reserve Bank of New Zealand for helpful discussion and comments. † Leo Krippner: Economics Department, Reserve Bank of New Zealand, 2 The Terrace, PO Box 2498, Wellington, New Zealand. Email address: leo.krippner@rbnz.govt. nz. Michelle Lewis: Economics Department, Reserve Bank of New Zealand, 2 The Terrace, PO Box 2498, Wellington, New Zealand. Email address: michelle.lewis@rbnz.govt. nz ISSN 1177-7567 c ©Reserve Bank of New Zealand Non-technical summary We investigate the real-time forecasting performance of macro-finance vector autoregression models, which incorporate macroeconomic data and yield curve component estimates as would have been available at the time of each forecast, for the United States. Our results show a clear benefit from using yield curve information when forecasting macroeconomic variables, both prior to the Global Financial Crisis and continuing into the period where the lower-bound constrained shorter-maturity interest rates. The forecasting gains, relative to traditional macroeconomic models, for inflation and the Federal Funds Rate are generally statistically significant and economically material for the horizons up to the four years that we tested. However, macro-finance models do not improve the real-time forecasts over shorter horizons for capacity utilization, our variable representing real economic activity. This is in contrast to the related recent macro-finance literature, which establishes such results (as do we) with pseudo real-time, i.e. truncated final-vintage, data. Nevertheless, for longer horizons that are more relevant for central bankers, yield curve information does improve activity forecasts. Overall, our results suggest that the yield curve contains fundamental information about the likely evolution of the macroeconomy. We find less convincing evidence for the reverse direction, which is likely because expectations of macroeconomic variables are already reflected in the yield curve. However, for longer horizons, we find there are still some gains from using macroeconomic variables to forecast the yield curve.