Download Issues related to forecasting framework and the medium term

NationalNational
BankBank
of ofRomania
Romania
Near Term
CPI and GDP Forecast
National Bank of Romania
Near Term CPI Forecast
¾ Two ARMAX models for the main components of
the CPI using monthly data expressed both as
annual growth rates (yoy) and monthly growth
rates (mom):
9 Food items (excluding volatile items: vegetables,
fruit and eggs)
9 Non-food items (excluding items with administered
prices, fuel and tobacco)
9 Services (excluding services with administered
tariffs)
¾ An expert forecast for CPI and its components
National Bank of Romania
Exogenous variables used in
ARMAX models
¾ Exogenous variables:
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9
9
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RON/EUR exchange rate
RON/USD exchange rate
Total economy net wage
HICP for euro area
Volatile prices (vegetables, fruit, eggs)
Administered prices
Fuels prices
Tobacco prices
¾ The ARMAX model with mom data allows us to
catch possible asymmetries in the exchange rate or
fuel pass-through
National Bank of Romania
Expert adjustments
¾ Expert adjustments can be done on
model’s equations too
¾ Source data for expert adjustments
includes:
9 Statements of regulatory authorities
9 Internal or external surveys
National Bank of Romania
Combining the forecasts
¾ In order to aggregate the forecasts obtained from
ARMAX models (mom model and yoy model), we
tested the following indicators:
9 RSS (52% mom, 48% yoy)
9 RSS/(N-k) (51% mom, 49% yoy)
9 Arithmetical mean
ƒ We use this method due to small differences vs. the other 2
methods
¾ The final projection is obtained by averaging the
aggregate forecast of the two models with the
expert forecast.
National Bank of Romania
Near term GDP forecast
¾
¾
Error correction models for GDP components
(quarterly data)
The structure of the model:
1. Equation for private consumption dynamics
2. Equation for gross capital formation dynamics
3. Equation for the export of goods and services
4. Equation for the import of goods and services
5. ARMA equation for inventories – residual in the GDP equation;
6. Assumption for public consumption
7. GDP = 1 + 2 +3 – 4 + 5 + 6
National Bank of Romania
Private consumption
¾ Long term equilibrium equation:
Consumption ↔ Disposable income
(proxy: total economy net wage)
¾ Short term dynamics explained by:
9 Private consumption lag
9 Real wage growth
9 Real ROBOR12M
9 Dummy variables for the years with very
high/low agricultural/farm output
National Bank of Romania
Gross capital formation
¾ Long term equilibrium equation:
Gross capital formation ↔ GDP and Foreign Direct
Investments
¾ Short term dynamics explained by:
9 Gross capital formation lag
9 Real ROBOR12M
9 FDI stock growth
9 Dummy variables which account for unusual
fluctuations in 2001 Q1 and 2004 Q4
National Bank of Romania
Exports
¾ Long term equilibrium equation :
Exports ↔ Euro area GDP (proxy: for external
demand) and RON/EUR real exchange rate
¾ Short term dynamics explained by:
9 Euro area GDP growth
9 RON/EUR real exchange rate growth
National Bank of Romania
Imports
¾ Long term equilibrium equation :
Imports ↔ Private consumption, Gross capital
formation and Exports
¾ Short term dynamics explained by:
9 Imports lag
9 Private consumption growth
9 Gross capital formation growth
9 Exports growth
9 RON/EUR real exchange rate growth
National Bank of Romania
The purpose of Near Term Forecasts
¾ NTF are discussed during the task-force
meetings;
9 Can suffer another sequence of expert
adjustments;
¾ NTF represent input data for MAPM – which is
the main model for medium term analysis and
projection;
9 Can be updated anytime during the forecasting
cycle if required by new data;
National Bank of Romania
The forecasting framework at the
NBR
and the model for medium term
analysis and projection
(MAPM)
National Bank of Romania
Forecasting process
¾ Steps:
9 Near term CPI and GDP forecast
9 Initial position in the business cycle (initial
conditions set)
9 Medium term projection
¾ Forecasting process:
9 Combining the model and the expert projection
9 Expert adjustments done in all 3 steps of the
forecasting process
National Bank of Romania
Model based projections
Combining projections from:
¾ Models for near term forecast – with almost all
parameters estimated (statistical relevance enhanced)
9 Currently used for near term CPI and GDP components
forecast
¾ Model for medium term analysis and projection –
with almost all parameters calibrated (theoretical
consistency enhanced)
9 Linear model with deterministic and unique solution
9 Starts from an estimated initial position (initial conditions set)
9 Use near term forecast
National Bank of Romania
Expert based projections
Refers to:
¾ Some of the near term forecasts (financial variables,
an expert projection for inflation)
¾ Exogenous events (ex. pre-announced tax changes,
market liberalization steps, UE accession etc.)
¾ Scenarios for administered and volatile prices
¾ Other variables non-included in the model (ex. fiscal
impulses)
¾ Other adjustments discussed in the task-force and the
Monetary Policy Committee (MPC)
National Bank of Romania
Output of the forecasting process (1)
¾ One baseline scenario for inflation and
other relevant macroeconomic indicators;
¾ This is the most likely scenario;
¾ Must be understood in correlation with
certain risk factors;
→ more details in Risks and uncertainties
surrounding the projection section in the
Inflation Report
National Bank of Romania
Output of the forecasting process (2)
Unique path for projected inflation and not a fan chart
or a range because:
¾ Short history and size/ frequency of structural breaks
makes harder to obtain a reliable statistical distribution for
errors (ex. until 2004 fuel prices were administered, and
liberalized after);
¾ For now, we prefer this method for its simplicity and for its
contribution in anchoring inflation expectation;
¾ Major disadvantage concerns the disconnection between
the presentation of the baseline scenario and the risks
associated with it;
National Bank of Romania
Timetable of the forecasting process
Time
Event
Detalii
T-45
Task Force meeting
Issue related to model specification, recalibration, future development –
twice per year
T-35
Task Force meeting
Near term forecast for CPI, GDP, interest rate, exchange rates and
exogenous scenarios for administered and volatile prices
T-28
Task Force meeting
Initial condition set (output gap, real exchange rate gap, real interest
rate gap) and equilibrium trends (including their forecast for the
projection horizon)
T-22
MPC meeting
Discussion of the initial conditions set and equilibrium trends
T-16
Task Force meeting
Projection scenarios
T-10
MPC meeting
Discussion of the baseline and risk scenarios
Inflation Report
Inflation Report sent for MPC discussion and approval
T+3
MPC meeting
Discussion of the Inflation Report
T+10
NBR Board meeting
Discussion of the Inflation Report, Monetary Policy Decision
T
¾ Task Force = discussion forum under the supervision of Deputy Governor Cristian Popa.
Includes directors and experts form Monetary Policy and Macroeconomic Modelling
Department and Economic Studies Department.
¾ MPC = Monetary Policy Committee – main discussion forum for monetary policy decision
proposals. Includes NBR executives, directors and other experts.
National Bank of Romania
Model for medium term analysis and
projection (MAPM) (1)
¾ A stylized and simplified description of the
transmission mechanism from monetary policy to
relevant macroeconomic variables and inflation.
¾ Model’s role
9 Consistently integrates all relevant information;
9 Generates an inflation projection and an interest rate
path which serve as a guideline for NBR Board
decisions regarding monetary policy;
9 Allows comparison between different alternative
scenarios;
National Bank of Romania
Model for medium term analysis and
projection (MAPM) (2)
¾ Properties:
9 Relatively small number of behavioral equations;
9 Log-linear specification around an unique steady-state solution;
9 Semi-structural Neo-Keynesian core, but parameters are not
necessarily structural;
9 Parameters are calibrated with respect to:
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Theoretical and empirical (from VAR models) moments matching;
In sample forecast properties ;
Expert judgment coming from NBR experts’ professional experience;
Benchmark values found in the relevant econometric literature;
9 Mix of forward-looking and backward-looking variables in some
equations (Phillips curve, interest rate parity, NBR reaction function).
National Bank of Romania
Transmission mechanism in the MAPM
NBR interest rate
Loans’ interest
rate
Deposits’ interest
rate
Consumption
and investment
Loans
Consumption/
Saving
Behavior
Foreign interest rate
Exchange Rate
Net
exports
channel
Balance sheet
and wealth
effect
Fiscal policy
Balassa-Samuelson
Effect
Output Gap
Exchange Rate
Pass-through
Import price
inflation
CPI Inflation
CORE2 Inflation
Expectations
National Bank of Romania
Administered
and Volatile price
inflation
Monetary policy transmission
mechanism
¾ Interest rate channel:
9 Relatively slow and still inefficient;
9 Monetary policy impulses transmitted through commercial banks’ interest
rates;
9 Net debtor position for NBR;
9 Financial markets still lack depth but quickly “catching-up” Æ could diluted
monetary policy impulses also.
¾ Exchange rate channel: relatively fast, with a direct impact on import price
inflation (including fuel price inflation) and also for some excises set in euro; and
an indirect impact via output gap.
¾ Balance sheet and wealth effects: important because of the significant degree
of currency substitution (euroisation/ dolarisation).
¾ Expectations channel: important for inflation projection; includes second round
effects coming from any inflationary factors.
National Bank of Romania
Model’s equations (1)
¾ Inflation components:
9 CORE2 inflation
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Core2 inflation lag
CPI expectations
Output gap
Import price inflation
Balassa Samuelson effect
9 Administered prices inflation (exogenous scenario based on expert forecasts, based on
discussions with the regulatory authorities)
9 Fuel price inflation
ƒ Fuel price inflation lag
ƒ International oil price (Brent)
ƒ RON exchange rate (vs. EUR for taking into account the effects of excises , vs. USD for
imports)
ƒ CPI inflation expectations
9 Volatile prices inflation (exogenous scenario, expert forecast for the projection horizon)
ƒ Lags and seasonal factors of volatile price inflation
ƒ RON/EUR exchange rate
ƒ Fuel price inflation
National Bank of Romania
Model’s equations (2)
¾ Output gap
Output gap lag
Lending and deposit interest rates (inter-temporal substitution)
Real effective exchange rate (intra-temporal substitution, local vs. imported goods)
A proxy for balance sheet and wealth effect: real EURIBOR and real exchange rate
depreciation (opposite influence than the effect on net exports)
9 Fiscal impulse (exogenous, based on Government program + structural and cyclical
decomposition)
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9
¾ Exchange rate
9 Interest rate differential vs. EURIBOR
9 backward and forward looking expectations
9 Risk premium
¾ NBR interest rate (adjusted to the NBR Board implied reaction
function)
9 Expected deviation of CPI inflation from target
9 Output gap
9 Interest rate smoothing
National Bank of Romania
MAPM track changes (1)
¾
Initial MAPM structure was quite standard: CORE1 inflation
equation (excluding administered prices), output gap equation
(real NBR interest rate, real RON/EUR), uncovered interest
rate parity, inflation expectations based on quarterly data,
reaction function
¾
Changes:
9 Inflation expectations equation specified in annual terms – smoothing
quarterly data
9 Splitting CORE1 inflation into: CORE2, fuel and volatile (LFO vegetables, fruit, eggs)
9 Appropriately specifying the real effective exchange rate by including the
RON/USD exchange rate (USD/EUR forecast from Consensus
Forecasts)
9 Including commercial banks’ sector with specific lending and deposits
interest rate
National Bank of Romania
MAPM track changes (2)
¾ Including a synthetic variable = real EURIBOR + real effective exchange
rate depreciation (in gap terms) for adequately capturing:
9 Changes in the cost of foreign currency denominated loans (including reserve
requirements changes);
9 Balance sheet and wealth effects;
¾ Periodic recalibration of the parameters whenever new empirical evidence
emerges: parameters for the behavioral equations (maximum once a
year), others parameters (more often, depending on the relative size of
the gap variables or on expert opinion regarding the speed of adjustment
to long run equilibrium – ex.: GDP potential growth, real exchange rate,
lending and deposits interest rate spreads vs. NBR interest rate etc.);
¾ Non-included in the MAPM:
9 Filtering the output gap by excluding the agricultural contribution to GDP - was
not enough superior to the existing method;
9 Term structure of interest rates (not a good trade-off benefits vs. costs);
National Bank of Romania
The future of MAPM
¾ Explicitly modelling GDP components (in
progress) and labor market – wage dynamics (in
perspective);
¾ Refining the fiscal impulse (integrated as an
exogenous variable to the output gap equation);
¾ Developing a new dynamic general equilibrium
model (DGE):
9 Superior analitical and explanatory power;
9 Tehnical assistance received from the National
Bank of Czech Republic/ IMF;
National Bank of Romania