Research Discussion Paper – RDP 2007-03 Forecasting with Factors: The Accuracy of Timeliness Abstract

This paper demonstrates that factor-based forecasts for key Australian macroeconomic series can outperform standard time-series benchmarks. In practice, however, the advantages of using large panels of data to construct the factors typically comes at the cost of using less timely series, thereby delaying when the forecasts can be made. To produce more timely forecasts it is possible to use a narrower data panel, though this will possibly result in less accurate factor estimates and so less accurate forecasts. We demonstrate this trade-off between accuracy and timeliness with out-of-sample forecasts. With the exception of only consumer price inflation, the forecasts do not become less accurate as they utilise less information by excluding less timely series. So while factor forecasts have large data requirements, we show that these should not prevent their practical use when timely forecasts are needed.

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