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Real-time Prediction with UK Monetary Aggregates in the Presence of Model Uncertainty

Anthony Garratt, Gary Koop, Shaun P. Vahey, Emi Mise

A popular account for the demise of the UK's monetary targeting regime in the 1980s blames the fluctuating predictive relationships between broad money and inflation and real output growth. Yet ex post policy analysis based on heavily-revised data suggests no fluctuations in the predictive content of money. In this paper, we investigate the predictive relationships for inflation and output growth using both real-time and heavily-revised data. We consider a large set of recursively estimated Vector Autoregressive (VAR) and Vector Error Correction models (VECM). These models differ in terms of lag length and the number of cointegrating relationships. We use Bayesian model averaging (BMA) to demonstrate that real-time monetary policymakers faced considerable model uncertainty. The in-sample predictive content of money fluctuated during the 1980s as a result of data revisions in the presence of model uncertainty. This feature is only apparent with real-time data as heavily-revised data obscure these fluctuations. Out of sample predictive evaluations rarely suggest that money matters for either inflation or real output. We conclude that both data revisions and model uncertainty contributed to the demise of the UK's monetary targeting regime.
Garratt, Anthony, Gary Koop, Emi Mise and Shaun Vahey (2009). ‘Real-time prediction with U.K. monetary aggregates in the presence of model uncertainty’, Journal of Business and Economic Statistics, Taylor and Francis Journals, Volume 27(4), Pages 480-491, DOI: https://doi.org/10.1198/jbes.2009.07208.