Forecasting with a forward-looking DGE model: combining long-run views of financial markets with macro forecasting

To develop forecasting procedures with a forward-looking dynamic general equilibrium model, we built a small New-Keynesian model and calibrated it to euro area data. It was essential in this context that we allowed for long-run growth in GDP. We brought additional asset price equations based on the expecta-tions hypothesis and the Gordon growth model, into the standard open economy model, in order to extract information on private sector long-run expectations on fundamentals, and to combine that information into the macro economic forecast. We propose a method of transforming the model in forecasting use in such a way, as to match, in an economically meaningful way, the short-term forecast levels, especially of the model's jump-variables, to the parameters affecting the long-run trends of the key macroeconomic variables. More specifically, in the model we have used for illustrative purposes, we pinned down the long-run inflation expectations and domestic and foreign potential growth-rates using the model's steady state solution in combination with, by assumption, forward looking information in up-to-date financial market data. Consequently, our proposed solution preserves consistency with market expectations and results, as a favourable by-product, in forecast paths with no initial, first forecast period jumps. Further-more, no ad hoc re-calibration is called for in the proposed forecasting procedures, which clearly is an advantage from point of view of transparency in communication.forecasting; New Keynesian model; DSGE model; rational expectations; open economy

The BOF5 Macroeconomic Model of Finland, Structure and Equations

This report is the basic documentation of the present (fifth) version of the Bank of Finland macroeconomic model, BOF5, built for policy simulation and forecasting. In constructing the model, consistent treatment of expectations is emphasized. Following current theoretical literature, intertemporal optimization with rational expectations is taken as the starting point, and Euler equations are applied in the estimation of the key behavioural equations. Consistent treatment of technology on the supply side has been another important aim. We illustrate the properties of the model with some simulation experiments. A complete list of equations and an outline of the derivation of the key equations are presented. We also show how forward-looking equations have been transformed to facilitate simulation under alternative assumptions concerning the formation of expectations.macroeconomic models; Finland; econometric modelling; policy simulations; expectations; Euler equations