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A Use of Index Models in Macroeconomic Forecasting

Staff Report 78 | Published October 1, 1982

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Author

Robert B. Litterman

A Use of Index Models in Macroeconomic Forecasting

Abstract

This paper illustrates the application of observable index models to the problem of macroeconomic forecasting. In this context, a Bayesian prior is used to describe a class of models which impose the index structure with more or less weight. An out-of-sample forecasting experiment is used to measure the possible benefits of this approach. In addition, impulse response functions and the decomposition of forecast variance are analyzed to suggest a possible separation of real and nominal shocks into separate channels.