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The importance of Economic Policy Uncertainty in forecasting GDP Growth: A forecast evaluation using a Bayesian vector autoregressive model
Uppsala University, Disciplinary Domain of Humanities and Social Sciences, Faculty of Social Sciences, Department of Economics.
2017 (English)Independent thesis Advanced level (degree of Master (Two Years)), 20 credits / 30 HE creditsStudent thesis
Abstract [en]

In this paper, I study how the forecast accuracy of GDP growth in a small open economy is affected by the inclusion of economic policy uncertainty. This is performed in the context of Sweden, using an economic policy uncertainty (EPU) index created by Armelius et al. (2016) based on the original index by Baker et al. (2016). I employ a Bayesian VAR model using data from 1993Q1 to 2016Q4. The point forecast accuracy is obtained in an out-of-sample rolling forecast evaluation using two measurements; the Root Mean Square Error and the Absolute Mean Error. In addition, the forecast density is evaluated comparing the Log Predictive Density Score (LPDS) and the coverage probabilities of the forecast intervals. The results show that the inclusion of the EPU index improves the point forecast accuracy for all horizons, in the MAE measure, and for five horizons ahead, in the RMSE measure. Further, the LPDS becomes lower by the inclusion of the index; however the forecast intervals are negligibly affected. The improvement in the size of all forecast measures is however rather modest, and find low statistical support. The conclusion is that the use of the EPU index does not significantly improve the forecast of GDP growth, leading to a discussion if the EPU index is good proxy for economic policy uncertainty.

Place, publisher, year, edition, pages
2017.
Keywords [en]
Policy uncertainty index (EPU), Bayesian VAR, small open economy, GDP growth
National Category
Economics
Identifiers
URN: urn:nbn:se:uu:diva-326440OAI: oai:DiVA.org:uu-326440DiVA, id: diva2:1121189
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Available from: 2017-08-18 Created: 2017-07-10 Last updated: 2017-08-18Bibliographically approved

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