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.