Forecasting Key Macroeconomic Variables of the South African Economy: A Small Open Economy New Keynesian DSGE-VAR Model

Rangan Gupta and Max Steinbach

No 201019, Working Papers from University of Pretoria, Department of Economics

Abstract: The paper develops a Small Open Economy New Keynesian DSGE-VAR (SOENKDSGEVAR) model of the South African economy, characterised by incomplete pass-through of exchange rate changes, external habit formation, partial indexation of domestic prices and wages to past inflation, and staggered price and wage setting. The model is estimated using Bayesian techniques on data for South Africa and the United States (US) from the period 1990Q1 to 2003Q2, and then used to forecast output growth, inflation and a measure of nominal short-term interest rate for one- to eight-quarters-ahead over an out-ofsample horizon of 2003Q3 to 2008Q4. The forecast performance of the SOENKDSGEVAR model is then compared with an independently estimated DSGE model, the classical VAR and BVAR models, with the latter being estimated based on six alternative priors, namely, Non-Informative and Informative Natural Conjugate priors, the Minnesota prior, Independent Normal-Wishart Prior, Stochastic Search Variable Selection (SSVS) prior on VAR coefficients and SSVS prior on both VAR coefficients and error covariance. Overall, we can draw the following conclusions: First, barring the BVAR model based on the SSVS prior on both VAR coefficients and the error covariance, the SOENKDSGE-VAR model is found to perform competitively, if not, better than all the other VAR models for most of the one- to eight-quarters-ahead forecasts. Second, there is no significant gain in forecasting performance by moving to a DSGE-VAR framework when compared to an independently estimated SOENKDSGE model. Finally, there is overwhelming evidence that the BVAR model based on the SSVS prior on both VAR coefficients and the error covariance is the best-suited model in forecasting the three variables of interest.

Keywords: Bayesian Methods; Macroeconomic Forecasting; New Keynesian DSGE; Small Open Economy; Vector Autoregressions (search for similar items in EconPapers)
JEL-codes: C11 C53 E37 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2010-09
New Economics Papers: this item is included in nep-afr, nep-cba and nep-for
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:pre:wpaper:201019

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