Forecasting the Australian economy with DSGE and BVAR models

Abstract

Reflecting the importance of commodities for the Australian economy, we construct a dynamic stochastic general equilibrium (DSGE) model of the Australian economy with a commodity sector. We assess whether its forecasts can be improved by using it as a prior for an empirical Bayesian vector autoregression (BVAR). We find that the forecasts from the BVAR tend to be more accurate than those from the DSGE model. Nevertheless, for output growth these forecasts do not outperform benchmark models, such as a small open economy BVAR estimated using the standard priors for forecasting. A Bayesian factor augmented vector autoregression produces the most accurate near-term inflation forecasts.