Instability and Non-Linearity in the EMU

Massimiliano Marcellino

No 3312, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In this Paper we evaluate the relative performance of linear, non-linear and time-varying models for about 500 macroeconomic variables for the countries in the Euro area, using a real-time forecasting methodology. It turns out that linear models work well for about 35% of the series under analysis, time-varying models for another 35% and non-linear models for the remaining 30% of the series. The gains in forecasting accuracy from the choice of the best model can be substantial, in particular for longer forecast horizons. These results emerge from a detailed disaggregated analysis, while they are hidden when an average loss function is used. To explore in more detail the issue of parameter instability, we then apply a battery of tests, detecting non-constancy in about 20-30% of the time series. For these variables the forecasting performance of the time-varying and non-linear models further improves, with larger gains for a larger fraction of the series. Finally, we evaluate whether non-linear models perform better for three key macroeconomic variables: industrial production, inflation and unemployment. It turns out that this is often the case. Hence, overall, our results indicate that there is a substantial amount of instability and non-linearity in the EMU, and suggest that it can be worth going beyond linear models for several EMU macroeconomic variables.

Keywords: Instability; Non-linearity; Time-varying models; Non-linear models; European monetary union (search for similar items in EconPapers)
JEL-codes: C53 E30 (search for similar items in EconPapers)
Date: 2002-04
New Economics Papers: this item is included in nep-eec, nep-ifn and nep-mac
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Citations: View citations in EconPapers (38)

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