M9902: Getting in touch with QPM
František Brázdik
Macroeconomic Forecasting Division
frantisek.brazdik@cnb.cz
Czech National Bank
November 2011
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Outline
1 Issues in the forecast
2 Case studies
3 Sensitivity analysis
4 Stress Scenarios
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Issues in the forecast
Outline
1 Issues in the forecast
2 Case studies
3 Sensitivity analysis
4 Stress Scenarios
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Issues in the forecast
Forecast issues
Use of expert judgement
Model change
Data preparation
Exogenous shocks
Tax changes: First-round and Second-round effects
Subsidies
Fiscal policy
Risk premium: Exchange rate behavior
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Issues in the forecast
Forecast evaluation
Alternative scenarios and sensitivity analysis:
Exchange rate sensitivity
Alternative scenarios: Exogenous variables forecasts
Stress scenarios for financial stability studies
Forecast effects decomposition:
Forecast decomposition: information groups - outlooks for
foreign economy, fiscal policy, taxes, etc.
Forecast changes decomposition: What changes drive forecast?
Evaluation of forecast 6 quarters ago: Fulfilment of inflation
target
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Case studies
Outline
1 Issues in the forecast
2 Case studies
3 Sensitivity analysis
4 Stress Scenarios
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Case studies Tax changes
Taxes I
Why to Deal with Taxes?
Tax reforms affect inflation −→ should be incorporated in
inflation projection
CNB applies escape clauses on first-round impacts of change in
taxation −→ no reaction of policy function
=⇒ Inflation excluding first-round impacts of indirect tax changes,
called also Monetary Policy Inflation,
or Inflation Relevant for MP)
Tax changes distort inflation expectations −→
expectations formation should be adjusted
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Case studies Tax changes
Taxes II
Inflation and MP Inflation
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Case studies Tax changes
Indirect Taxes III
Requirements
Information about planned changes in indirect taxes
Precise estimation of direct first-round effects
Estimation of primary effects: use CPI basket to asses
Estimation of impact on inflation expectations formation
(second-round effects): wealth effect
Good enough estimation of direct second-round effects e.g.
margin absorption, price stickiness
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Case studies Tax changes
Taxes IV
Issue I: Foreign Taxes
Should be treated similarly
Typically, not enough information nor good estimates of impact
on foreign inflation
Issue II: Real Exchange Rate (RER)
Within the simple model framework, RER is defined involving
CPI rather than PPI inflation rates
From theory, RER should be adjusted to changes in indirect
taxes (domestic and foreign)
However it is difficult to apply, having usually small effects on
projection
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Case studies Tax changes
Tax changes
Czech Experience:
From January 2004 - domestic VAT changes incorporated
From April 2006 - foreign VAT changes incorporated
From April 2007 - RER adjustment applied
Quantification of effects of tax changes: Time profile and size
of impact (volatility of forecast)
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Case studies Tax changes
More tax issues
1 Foreign tax change
Should be treated similarly
Typically, not enough information nor good estimates of impact
on foreign inflation
2 Real Exchange Rate (RER)
Within the simple model framework, RER is defined involving
CPI rather than PPI inflation rates
From theory, RER should be adjusted to changes in taxes
(domestic and foreign)
However it is difficult to apply, having usually small effects on
projection
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Case studies Oil shock
Oil price I
Czech Experience:
Oil price shock started in autumn 2005, peak in summer 2008
Small weight of fuel prices (around 3% in CPI)
Expected increase in fuel prices and regulated prices
Very large increase in oil prices as well as their maintaining at
high levels is no longer consistent with behavioral mechanism
described in QPM (affects inflation expectations)
Systematic upward bias of inflation over several periods,
especially in adjusted inflation excluding fuels
At the same time, nominal exchange rate appreciated rapidly in
comparison with the forecast
Outlook of foreign variables affected - use of a global economy
model
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Case studies Oil shock
Oil price II
Oil Prices - Brent
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Case studies Oil shock
Implementation I
Effects to administered prices: energy for households
Energy price inflation: non-administered portion of consumption
basket
Impact on foreign inflation
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Case studies Consumption basket
Revision of CPI Weights I
Czech Experience:
New weights introduced from January 2007
Previous revision in January 2001
Model framework assumes constant weights in CPI
QPM forecasts since July 2002: New experience
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Case studies Consumption basket
Revision of CPI Weights II
Computing q-o-q and y-o-y inflation correctly: Auxiliary indices
CPI1 and CPI4 were introduced
Smooth transition
Systematic shift in inflation: Structural change in real
equilibrium exchange rate
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Sensitivity analysis
Outline
1 Issues in the forecast
2 Case studies
3 Sensitivity analysis
4 Stress Scenarios
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Sensitivity analysis
Analysis I
Model is not closed in the sense of S. Schmitt-Grohe and M.
Uribe (2003)
What is the difference in scenario of appreciation and
depreciation?
Linear model properties
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Sensitivity analysis
Analysis II
Depreciation
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Sensitivity analysis
Analysis III
Appreciation
Reporting in the SR:
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Sensitivity analysis
Analysis IV
Appreciation by 3%
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Sensitivity analysis
Shock persistence I
Volatile development of exchange rate: January 2007
Re-simulation of sensitivity scenario
Standard simulation: No persistence in shock
Advanced simulation: Various degrees of autocorrelation
Results:
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Stress Scenarios
Outline
1 Issues in the forecast
2 Case studies
3 Sensitivity analysis
4 Stress Scenarios
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Stress Scenarios
Stress testing
Cooperation with supervision units
Scenario for financial stability department
Scenarios for the bank risks evaluations models
Series used for probability of defaults calculations
Goals:
Usually unfavorable developments to be modeled
Probability of defaults calculations: economy wide
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