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Merging Structural and Reduced-Form Models for Forecasting

  • Jaime Martinez-Martin EMAIL logo , Richard Morris , Luca Onorante and Fabio Massimo Piersanti
Published/Copyright: February 15, 2024
The B.E. Journal of Macroeconomics
From the journal The B.E. Journal of Macroeconomics Volume 24 Issue 1

Abstract

Recent economic crises have posed important challenges for forecasting. Models estimated pre-crisis may perform badly when normal economic relationships have been disrupted. Meanwhile, forecasting, especially in central banks, is increasingly based on a suite of models, following two main approaches: structural (DSGE) and reduced form. The challenge remains to identify which model – or combination of models – is likely to make better forecasts in a changing environment. We explore this issue by assessing the forecasting performance of combinations of a medium-scale DSGE model with standard reduced-form methods applied to the Spanish economy and a reference period that includes both the great recession and the sovereign debt crisis. Our findings suggest that: (i) the mean reverting properties of the DSGE model cause it to underestimate the growth of real variables following the inclusion of crisis episodes in the estimation period; (ii) despite this, reduced-form VARs benefit from the imposition of an economic prior from the structural model; but (iii) pooling information in the form of variables extracted from the structural model with (B)VAR methods does not improve forecast accuracy. By analysing the quantiles of the predictive distributions, we also provide evidence that merging models can help improve the forecast in a context including crisis episodes.

Keywords: macroeconomic forecasting; multivariate time series; DSGE models; Bayesian VARs
JEL Classification: C54; E37; F3; F41
Corresponding author: Jaime Martinez-Martin, Banco de España, Madrid, Spain, E-mail:

We are extremely grateful to Marco Del Negro, Marco Ratto, Jesús Fernández-Villaverde, Philip Lane, Diego Rodríguez-Palenzuela, Barbara Rossi, Juan F. Rubio-Ramírez and seminar participants at the European Central Bank, at the 2019 International Association for Applied Econometrics Annual Conference (Nicosia), and at the 3rd Forecasting at Central Banks Conference (Ottawa) for their stimulating and helpful comments. Also, we are thankful to the Editor and two anonymous referees for their comments and suggestions. The views expressed in the paper are those of the authors and do not necessarily reflect those of the ECB, the Banco de España, the Banca d’Italia, the European Commission or the Eurosystem. No part of our compensation was, is or will be directly or indirectly related to the specific views expressed in this paper. All remaining errors are our own responsibility.

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Supplementary Material

This article contains supplementary material (https://doi.org/10.1515/bejm-2022-0170).

Received: 2022-10-27
Accepted: 2023-12-30
Published Online: 2024-02-15

© 2024 Walter de Gruyter GmbH, Berlin/Boston

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https://doi.org/10.1515/bejm-2022-0170
Keywords for this article
macroeconomic forecasting; multivariate time series; DSGE models; Bayesian VARs

Articles in the same Issue

  1. Frontmatter
  2. Advances
  3. Optimal Taxation of Informal Firms: Misreporting Costs and a Tax Reform in Brazil
  4. Initial Beliefs Uncertainty
  5. Credit Resource Misallocation and Macroeconomic Fluctuations in China: From the Perspective of Heterogeneous Financial Frictions
  6. The Bitcoin Premium: A Persistent Puzzle
  7. Contributions
  8. Intermediate Goods–Skill Complementarity
  9. Perfect Competition and Fixed Costs: The Role of the Ownership Structure
  10. Optimal Monetary Policy with Government-Provided Unemployment Benefits
  11. Employment Protection in Dual Labor Markets: Any Amplification of Macroeconomic Shocks?
  12. A Tide that Lifts Some Boats: Assessing the Macroeconomic Effects of EU Enlargement
  13. Current Account Balances’ Divergence in the Euro Area: An Appraisal of the Underlying Forces
  14. Merging Structural and Reduced-Form Models for Forecasting
  15. Trust in Government in a Changing World: Shocks, Tax Evasion, and Economic Growth
  16. The Fiscal Multiplier of Public Investment: The Role of Corporate Balance Sheet
  17. Does Uncertainty Matter for the Fiscal Consolidation and Investment Nexus?
  18. Government Spending Between Active and Passive Monetary Policy: An Invariance Result
  19. A DSGE Model with Government-owned Banks
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