Have structural changes eliminated the out-of-sample ability of financial variables to forecast real activity after the mid-1980s? Evidence from the Canadian economy

Abstract

This article evaluates how consistently reliable the information content of individual financial variables is for Canada's future output growth. We estimate the timing of structural changes in linear growth models and check robustness to specification changes, multiple breaks, and business cycle asymmetry. Our simulated out-of-sample forecast evaluation strategy, using the Mean Square Error F-type (MSE-F) and the new encompassing (ENC-NEW) tests, shows that the leading information content of most financial variables for Canada's future Gross Domestic Product (GDP) growth has deteriorated substantially after 1984:04, but the 1--3-year term spread exhibits a consistently reliable predictive ability at the 1 and 2 quarter horizons and has significant forecasting ability at the 8 quarter horizon. Also, the real M1 money growth has regained its ability to forecast output growth since 1991:01.