Combining country-specific forecasts when forecasting Euro area macroeconomic aggregates

Abstract

European Monetary Union (EMU) member countries' forecasts are often combined to obtain the forecasts of the Euro area macroeconomic aggregate variables. The aggregation weights which are used to produce the aggregates are often considered as combination weights. This paper investigates whether using different combination weights instead of the usual aggregation weights can help to provide more accurate forecasts. In this context, we examine the performance of equal weights, the least squares estimators of the weights, the combination method recently proposed by Hyndman et al. (2011) and the weights suggested by shrinkage methods. We find that some variables like real GDP and GDP deflator can be forecasted more precisely by using flexible combination weights. Furthermore, combining only forecasts of the three largest European countries helps to improve the forecasting performance. The persistence of the individual data seems to play an important role for the relative performance of the combination.

Euro Area Income and Wealth Effects: Aggregation Issues*

“…What is new compared to other studies reporting on country aggregation bias (Pesaran, and Smith, 1995;Marcellino et al, 2003;Ruth, 2008;Flavin et al, 2009;Monteforte and Siviero, 2010) is that our application uses a large number of private consumption model specifications rather than focus on one or a few specifications. In addition, other studies (Monteforte, 2007;Zeng, 2016) illustrate the country aggregation bias by aggregating across the three largest euro area countries, whereas we aggregate across the four largest euro area countries (hereafter EA4). The advantage is that the consumption expenditure weight of the EA4 amounts to almost 80% of the full euro area aggregation.…”