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Evaluating density forecasts - model combination strategies versus the RBNZ

Chris McDonald, Leif Anders Thorsrud

Forecasting the future path of the economy is essential for good monetary policy decisions. The recent financial crisis has highlighted the importance of tail events, and that assessing the central projection is not enough. The whole range of outcomes should be forecasted, evaluated and accounted for when making monetary policy decisions. As such, we construct density forecasts using the historical performance of the Reserve Bank of New Zealand's (RBNZ) published point forecasts. We compare these implied RBNZ densities to similarly constructed densities from a suite of empirical models. In particular, we compare the implied RBNZ densities to combinations of density forecasts from the models. Our results reveal that the combined densities are comparable in performance and sometimes better than the implied RBNZ densities across many different horizons and variables. We also find that the combination strategies typically perform better than relying on the best model in real-time, that is the selection strategy.