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Forecast performance of inflation in BRICS and OPEC countries

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Department of Economics, Kingston University London, Penrhyn Rd, KT1 2EE, UK.

Abstract

In this research, we estimate a benchmark model (naïve model) for annual inflation and

compare its forecasting performance with the best selected univariate ARIMA/ARIMAX

specification and the nonlinear TAR model estimated over full sample and a reduced sample

that designed to avoid modelling breaks. This result shows that the benchmark (naïve models)

was never favoured over the both selected nonlinear TAR model and different ARIMA models

for selected countries. Our results also indicate that the models estimated over the reduced

sample exhibit superior forecasting performance compared to the model estimated over the full

sample in most countries. This implies that the potential benefits of having more data from

using the full sample are generally outweighed by being able to avoid modelling structural

breaks, even at the cost of a reduced sample for estimation. Given the extra time and modeller

expertise required to model such breaks this suggests that using reduced samples to avoid the

issue of structural breaks is generally the preferred strategy.

forecasting.

JEL Classification Codes: C01, C22, C51, E31.

1. Introduction

It is widely accepted that Inflation in developing countries is caused by monetary and structural

issues while inflation in the developed countries is caused by mainly monetary reasons

(Tavakkoli, 1996). For inflation forecasting, most studies have argued in favour of using

multivariate models over the univariate models although other studies have questioned the

performance of multivariate models over different forecasting horizons (Fritzer et al. 2002,

Onder 2004, Alnaa and Abdalla, 2005). In contrast, Atkeson and Ohanian (2001) showed that

univariate model (naïve model) outperforms multivariate (Phillips curve) in many cases. This

view is supported by Stock and Watson (2007) who revealed that univariate IMA(1,1)

specification are more accurate than the forecasts produced by the multivariate models in

United State for the period of 1960:q1 - 2004:q4. Pretorious and Rensburg (1996) stated that

univariate ARIMA model outperforms multivariate (Phillips curve model, Traditional

monetarist and money demand model) when the inflation is relatively stable and theory based

models are better at forecasting inflation when inflation is volatile. Mitra and Rashed (1996)

showed that the ARIMA model performed better than the other two models during the period

of stable inflation for one- quarter ahead forecasts. For the period of higher inflation and four-

quarter ahead forecasts, the VAR model performed better than the two other models. Lee

(2012) empirical results specified that inflation forecasts generated by the ARIMA model

performed better than inflation forecasts generated by the naïve and Phillips curve models for

most countries, especially for the period following the adoption of the inflation targeting.

The success of univariate model most especially ARIMA model over other selected model

during the period of stable inflation motivated this study to assess the forecasting performance

of different univariate ARIMA specifications and regime shift autoregressive model for

different economies over different period of time, to the best of our knowledge; we are not

aware of any publication that model ARIMAX/ARIMA models and compared its forecasting

performance to the threshold autoregressive model for BRCS and selected OPEC countries

most especially using the Bai and Perron (2003a and 2003b) test to account for time varying

seasonal pattern in annual inflation.1 In our study, we specifically examine the impact of

different approaches on the treatment of seasonality on ARIMA modelling when forecasting

inflation.2 We focus extensively on univariate ARIMA Model to forecast inflation, we compare

the forecasting performance of ARIMAX models estimated over the full sample and different

ARIMA specifications estimated on a reduced sample (with a minimum of 39 observations).

When using the full sample, we produce forecasts for ARIMAX models that have a

deterministic component to account for structural breaks using dummy variables and

seasonality that is modelled using seasonal dummy variables and seasonal AR and MA terms.

The reduced sample modelling is designed to avoid structural breaks such that there is no need

for deterministic terms to model such shifts. The first set of ARIMA models are developed

using the reduced sample and include seasonal dummy variables and seasonal AR and MA

components. A second set of ARIMA models developed for the reduced sample employ

EViews 9’s automatic seasonal ARIMA model specification routine. A third set of ARIMA

1

The recent literature that close to our methodology is the empirical study of Ozmen and Sanli, (2017). The

difference between this study and our approach is that Ozmen and Sanli study mainly focused on selecting the

best fitted model for ARIMA and this study does not compare the best selected SARIMA to other alternative class

of model. Therefore, it is very difficult to justify the performance of the best selected SARIMA model over

alternative model. Second, Ozmen and Sanli study applied HECY and Canova- Hansen (CH) test to determine

order of seasonal differencing on monthly Turkish inflation and later applied seasonal ARIMA based on stepwise

and non-stepwise selection. The limitation of this study to our research is that, the study of Ozmen and Sanli does

not include deterministic model to capture the effect of both seasonality and seasonal unit root. Therefore,

imposing one type of seasonality method, when another should be considered may likely have effect on inflation

forecasting. Third, Ozmen and Sanli study only considered one emerging economy. Therefore, it is very difficult

to justify the conclusion of this study to other different economy environment.

2

The three approaches to the treatment of seasonality mentioned by Cosar (2006) were considered. The first

approach is to remove the seasonal component of a series through the use of deterministic dummies. The second

is to use seasonal differencing, or by the use of seasonal adjustment methods like the X-13 Arima or

Tramo/Seats. The third approach is to model the seasonality.

2

models were developed for the reduced sample where the data are first seasonally adjusted and

EViews 9’s automatic non-seasonal ARIMA model specification routine is employed. In this

latter case forecasts are re-seasonalised using the 2012 seasonal indices obtained from the

seasonal adjustment procedure. The other univariate model we considered include the regime

shift threshold Autoregressive model (over the full sample and reduced sample) and the naïve

model which added as a benchmark. We seek to assess the following. First, whether superior

forecasts can be obtained by using the full sample (with the benefit of more information) and

explicitly modelling the structural breaks (with the possibility of overfitting and difficulty in

adequately capturing such effects) or whether using reduced samples (with the disadvantage of

fewer data points) is compensated by the avoidance of having to model any structural breaks.

Second, whether quick automatic ARIMA selection procedures available in EViews’s can

produce as good forecasts as specifications produced using more time-consuming model

building techniques. Third, whether ARIMA specifications that explicitly model seasonality

are superior to specifications that apply non-seasonal models to seasonally adjusted data

followed by reseasonalising the forecasts. Fourth, whether regime shift threshold

autoregressive model (TAR model) produces superior forecasts over the univariate ARIMA

model selection? Lastly, of all the models considered, which model produces the best

forecasting performance over the benchmark model (naïve) across countries and/or for

different forecasting horizons?

3

2. Literature review

Evidence from previous studies showed that ARIMA model is the best to forecast inflation in

the short horizons. For example, Akhter (2013) estimates ARIMA (1,1,1) (1,0,1)12 and

produce a forecast for inflation for the period 2013 using monthly consumer price data between

January 2000 to December 2012. The study revealed that ARIMA model is valid to produce

the short-term forecast for Bangladesh for 2013. Also, Abdulrahman et. al. (2018) examined

whether the short term ARIMA models can be used to produce inflation forecast in Sudan

between the period 1970 to 2016. The result shows that there is a convergence between

predictive values and actual values during the estimated period. This result implies that a valid

ARIMA model can be obtained to forecast inflation in Sudan during the estimated period.

Study also show that when the ARIMA model is estimated and compared with other selected

models. ARIMA model mostly performs better than alternative models (e.g. Naive model and

multivariate VAR models) during periods of low and stable inflation than a period of high

inflation volatility. For example, Mitra and Rashed (1996) forecast Canadian inflation for one

and four quarters ahead and compared the predictive performance of VAR, ARIMA and Static

expectation models between 1972:q1 and 1986:q4. The series is divided into different samples

to reflect different periods economy environment (period of stable inflation and higher

inflation). The evidence revealed that the ARIMA model performed better than the other two

models during the period of stable inflation for one- quarter ahead forecasts. For the period of

higher inflation and four-quarter ahead forecasts, the VAR model performed better than the

ARIMA and Static model. Lee (2012) compares the predictive performance of the ARIMA

model, Phillips curve and naïve model for twenty-six countries that had adopted a policy of

inflation targeting since 1990. The period before the adoption of the policy and the period after

the inflation targeting policy were implemented. The results specified that inflation forecasts

generated by the ARIMA model performed better than inflation forecasts generated by the

naïve and Phillips curve models for most countries, especially for the period following the

adoption of the inflation targeting policy. To examine effect of structural changes on ARIMA

inflation forecasting. Junttila (2001) estimates two different ARIMA models to forecast

Finnish inflation between the period 1/1978 – 9/1996. The estimated period is characterised by

the period of high unemployment, high inflation, massive rise in house market and the effect

of the collapse of the Soviet Union that accompanied by the recession in Western markets. The

first ARIMA is estimated over the whole sample period without identifying the possible breaks.

While the second ARIMA model follows the study of Tsay (1988) and estimate ARIMA model

with the deterministic model to account for possible breaks. Junttila examines whether the

forecast of inflation obtained from ARIMA model that account for structural breaks produce

better forecast than alternative ARIMA model estimated without modelling breaks. From the

recursive forecast, the result showed that the ARIMA model estimated with intervention

models perform better than alternative ARIMA model estimated without breaks. Instead of

modelling breaks, Doguwa and Alade (2013) estimated seasonal ARIMAX model that

incorporates different macroeconomic variables as an exogenous. The author compares

forecast performance of the seasonal ARIMA model estimated with exogenous to seasonal

4

ARIMA model estimated without exogenous for Nigeria between July 2001 to September 2013

over the 12 months forecast horizon. The seasonal ARIMA estimated with exogenous performs

better than the alternative model. Finally, Ozmen and Sanli, (2017) advanced on HECY test

and applied both Osborn, Chui, Smith and Birchenhall (OCSB) test and Canova- Hansen (CH)

test to determine order of seasonal differencing on monthly Turkish inflation and later applied

“auto arima” function in “R software” chosen by stepwise and non-stepwise selection

procedure to select the best fitted ARIMA model. The result shows that the R software

automatic seasonal ARIMA model selected by non-stepwise produce the best fitted SARIMA

when compared with alternative ARIMA selection. The main conclusion from this section is

that the univariate ARIMA model produces a better forecast in a period of low inflation than a

period of high inflation. Also, the ARIMA model estimated to account for structural breaks or

incorporated with other exogenous variables outperform alternative ARIMA model estimated

without structural breaks or other exogenous variables.

3. Empirical methods

When series are quarterly, it is possible that the series will exhibit seasonality, and modelling

of such series requires the non-seasonal ARIMA model to be extended to accommodate

additional features of seasonality. In ARIMA modelling, seasonality can be dealt with in two

different ways: direct seasonal modelling of unadjusted data and by using seasonal adjustment

procedure. The adjusted seasonal method will seasonally adjust the data through, for example,

the X-13 or X-12 procedures and a non-seasonal ARIMA model can be used to forecast the

adjusted data. After which the identified seasonal indices are used to re-introduce the

seasonality into the forecasts. The unadjusted data method directly extends the non-seasonal

ARIMA model to capture the seasonal component of the series. In general, the seasonal

ARIMA model can be expressed as ARIMA (p,d,q)(P,D,Q)s. That is, there is a combination

of two polynomials generated by (p,d,q) and (P, D,Q)s, where P is the seasonal order of the

autoregressive component, D denotes the seasonal order of integration and Q represents the

seasonal order of moving average component. The parameter p, d, and q are the corresponding

non- seasonal orders of processes. The multiplicative seasonal ARIMA mode can be expressed

as follows:3

ø𝑝 (𝐵)ø𝑃 (𝐵 𝑠 )(1 − 𝐵)𝑑 (1 − 𝐵 𝑠 )𝐷 𝑌𝑡 = θ𝑞 (𝐵)θ𝑄 (𝐵 𝑠 )𝑢𝑡

(1)

Where B is the standard backward shift operator defined by BK𝑦𝑡 = 𝑦𝑡−𝑘 , ø𝑝 (𝐵) denotes the

nonseasonal autoregressive model, ø𝑃 (𝐵 𝑠 ) represents the seasonal autoregressive model, θ𝑞 (𝐵)

describes the nonseasonal moving average process, θ𝑄 (𝐵 𝑠 ) denotes seasonal moving average

process, and 𝑢𝑡 is a sequence of white noise errors that are assumed to have zero mean and

constant variance. (1 − 𝐵)𝑑 and (1 − 𝐵 𝑠 )𝐷 are the nonseasonal and seasonal differencing

operators, respectively. Finally, 𝑠 denotes the number of periods in the seasonal cycle.

Therefore:

3

Tseng and Tzeng, 2002; Zhang and Qi, 2005; Wang et al. 2012

5

ø𝑝 (𝐵) = (1 - ø1 𝐵 - ø2 𝐵 2 - ø3 𝐵 3 -...........− ø𝑝 𝐵 𝑝 ) (2)

variables to account for outliers and/or structural breaks. This could be referred to as an

ARIMAX model.4 The modelling of the outliers/breaks can take different forms such as: step-

shift, pulse, split trend or slope - shift.

In this case, the ARIMAX model can be specified as:

θ(𝐵)

𝑦𝑡 = 𝛽0 + 𝛽1 𝐷𝑖𝑡 𝑋𝑖𝑡 + 𝛽2 𝐷2𝑡 𝑋2𝑡 + ⋯ + 𝛽(𝐾−1) 𝐷(𝐾−1)𝑡 𝑋(𝐾−1)𝑡 + ∅(𝐵) e𝑡 . (6)

Where 𝑦𝑡 is the dependent variable, 𝑘 − 1 is the intervention variable, 𝐷𝑖𝑡 is the dummy

θ(𝐵)

variable, 𝛽0 and 𝛽𝑖 are the coefficients, 𝑋𝑖𝑡 are the explanatory variables, 𝑢𝑡 = e, i.e the

∅(𝐵) 𝑡

error term that is modelled by a univariate ARIMA(p,d,q). In our study, we focus on modelling

outliers and structural shifts using the dummy variables, 𝐷𝑖𝑡 , and we do not add any explanatory

variables, 𝑋𝑖𝑡 . And the step intervention allocates dummy variables as follows:

0 𝑖𝑓 𝑡 ≤ 𝑡𝑖

𝐷𝑖𝑡 = {

1 𝑖𝑓 𝑡 > 𝑡𝑖

Where 𝑋𝑖𝑡 = 1 (one outlier or break)

In this case, we model the possible intervention for annual rate of inflation in form of OLS and

apply the Bai Perron test for potential multilpe breaks. The details are given below:

𝑦𝑡 = 𝛿1 𝑆1𝑡 + 𝛿2 𝑆2𝑡 + 𝛿3 𝑆3𝑡 + 𝛿4 𝑆4𝑡 + 𝛿5 𝑡 + 𝜀𝑡 (7)

Where 𝑦𝑡 = annual inflation, the seasonal dummy variables are denoted as: 𝑆1𝑡 , 𝑆2𝑡 , 𝑆3𝑡 and

𝑆4𝑡 , and the time trend, 𝑡 =1,2,…., 𝑇, where 𝑆𝑠𝑡 = 1 in quarter 𝑆 = 1, 2, 3, 4. Further, we specify

shift dummy variables (that are zero prior to the break date and unity from the break date

onwards) interacted with the seasonal dummy variables to develop deterministic for ARIMAX

model. The contemporary equation can be written as:

𝐽 𝐽

𝑦𝑡 = 𝛾1 𝑆1𝑡 + 𝛾2 𝑆2𝑡 + 𝛾3 𝑆3𝑡 + 𝛾4 𝑆4𝑡 + ∑𝐽=1 𝛾1𝐽 (𝐷𝐽𝑡 × 𝑆1𝑡 ) + ∑𝐽=1 𝛾2𝐽 (𝐷𝐽𝑡 × 𝑆2𝑡 ) +

𝐽 𝐽 𝐽

∑𝐽=1 𝛾3𝐽 (𝐷𝐽𝑡 × 𝑆3𝑡 ) + ∑𝐽=1 𝛾4𝐽 (𝐷𝐽𝑡 × 𝑆4𝑡 ) + 𝛾5 𝑡 + ∑𝐽=1 𝛾5𝐽 (𝐷𝐽𝑡 × 𝑡) + 𝑤𝑡 (8)

4

Akal (2004) documents that ARIMAX modelling corrects the deficiencies of the econometric causal-effect

technique by using dynamic filters to explain the variations in endogenous variables.

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Where 𝐷𝐽𝑡 denote the 𝐽 dummy variables corresponding to 𝐽 Identified break dates that are

equal to zero prior to the break data and equal to one on after the break date and 𝑤𝑡 is the

stochastic error term. To justify the need to include the interaction terms in the equation (8),

we applied the t-test to test for the significance of the coefficient of the break point (𝐷𝑖𝑡 ). In

our study, we exclude all insignificant break points and include only dates that are significant.

Following Hendry (2001), Hendry and Santos (2005) and Caporale et al. (2012), we construct

an index of indicator variables to summarise the deterministic terms of the equation (8) in a

single variable to enhance the efficiency of estimation of the ARIMAX model. We regard this

indicator as the fitted value of the deterministic model and regress annual inflation on the

indicator. Further, we plot the graph of the autocorrelation function (ACF) and partial

autocorrelation function (PACF) of the residuals of this model and build possible ARIMAX

model that passes the diagnostic checks of invertibility, stationarity and no autocorrelation for

each country.

The summary of ARIMAX model that passes diagnostic test for each country is given in Table

1 and 2 and details of ARIMAX model that include intervention are specified below:

Where, I_(P) denote a single indicator index used to summaries the deterministic terms in

equation (8).

denote the standard backshift operator and 𝑝 and 𝑃 denote the respective orders of non-

seasonal and seasonal autoregressive (AR) processes and 𝑞 and 𝑄 denote the respective orders

of non seasonal and seasonal moving average (MA) processes.

Our expectation follows that presence of structural breaks may mean that inflation may not be

stationary in high inflation economies such as in many OPEC countries because, for example,

a downward shift in the intercept (seasonal indices), coinciding with a move from high to low

inflation eras or fluctuation of the global oil price may give a non-constant mean across the

whole sample period. Therefore, the non- linear model that can be used to capture this

behaviour is the threshold autoregressive (TAR) model first proposed by Tong (1978) and

discussed in detail by Tong and Lim (1980) and Tong (1983).

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TAR is considered as the self-exciting threshold autoregressive (SETAR) model when the

threshold variable is taken as the lagged value of the time series being modelled. The SETAR

assumes that a variable 𝑦𝑡 is a linear auto- regression within a regime but may move between

regimes depending on the value taken by a lag of 𝑦𝑡 , say, 𝑦𝑡−𝑑 where 𝑑 is the length of the

delay.

The simple AR(𝑝) model for a time series {𝑦𝑡 } follows the process:

Where 𝝓𝑖 (𝑖 = 1,2,…, 𝑝) are the AR coefficients, 𝜀𝑡 ˷ 𝑁(0,1) and 𝜎 > 0 is the standard

deviation of the disturbance term. The model parameters 𝝓 = (𝝓0 , 𝝓1 , 𝝓2 , … . . , 𝝓𝑝 ) and 𝜎 are

independent of time 𝑡 and remain constant. To capture nonlinear dynamics, TAR models can

be estimated as follow:

𝑦𝑡 = 𝝓𝑜 (𝑗) + 𝝓1 (𝑗) 𝑦𝑡−1 +…...+ 𝝓𝑝 (𝑗) 𝑦𝑡−𝑝 + 𝜀𝑡 (𝑗) if 𝑟𝑗−1 < 𝑧𝑡 ≤ 𝑟𝑗 , (11)

the number of regimes separated by 𝑘 − 1 nontrivial thresholds, {𝜀𝑡 (𝑗) } are independent

identical distributed sequences with zero mean and variance 𝜎𝑗 2 and are mutually independent

for different 𝑗. The parameter 𝑑 is the delay parameter, 𝑟𝑗 are thresholds, 𝑝 is denotes the AR

order and 𝝓𝑝 are the autoregressive coefficients. The summary of the valid TAR model

that passes diagnostic test for each country is given in Table 3 and 4.

Further, we estimate the naïve model as a benchmark model and compare its forecasting

performance with the best selected ARIMA and TAR specifications. The naïve model is

estimated by equating the observed value in the last quarter of the estimation period to forecast

the present quarter. That is:

𝑦𝑇+ℎ = 𝑦𝑇 (12)

where 𝑦𝑇+ℎ is the ℎ period ahead forecast and 𝑦𝑇 is the observed data in the last period of the

estimation sample.

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5. Emprical Data and Results

In this study, we considered the consumer price index that is quarterly and available from

International Financial Statistics (IFS) published by the International Monetary Fund (IMF) for

all selected countries.5 The availability of the sample for each country is varies and available

in the Table 1 and 2. The valid model for both reduced sample and full sample are also available

in the Table 1 and 2 for ARIMAX/ARIMA and Table 3 and 4 for nonlinear threshold model.

5

For all countries, we transformed the consumer price data into annual inflation using the following formula:

𝑃 −𝑃

𝐼𝑁𝐹𝑡 = 𝑡 𝑡−4. Where 𝐼𝑁𝐹𝑡 denote annual inflation rate, 𝑃𝑡 = denotes consumer price index at first quarter

𝑃𝑡−4

and 𝑃𝑡−4 denotes consumer price index at the fourth quarter

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Table 1. Summary of the univariate ARIMA specification for BRICS countries

Countries Brazil

Russia India China South Africa

Sample 1984Q1 1997Q2 1996q1 2003Q2 1961Q1 1992Q1 1961q1 1995Q2

2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4

(116) (63) (68) (39) (208) (84) (208) (71)

Model ARIMAX R_SARIMA R_A_SARIMA R_A_ARIMA ARIMAX R_SARIMA R_A_SARIMA R_A_ARIMA F_SARIMA F_A_SARIMA F_A_ARIMA F_SARIMA F_A_SARIMA F_A_ARIMA ARIMAX R_SARIMA R_A_SARIMA R_A_ARIMA

ARIMA (1,0) (0, 4) (1,1) (0,4) (0,5) (1, 3) (2,2) (1,3) (4,3) (1,3) (1,3) (2,3) (3,2) (1, 4) (1,1) (1, 1) (1,1) (2,2)

(2,1) (0,1) (2, 2,) (0,0) (0,1) (1,0) (0,1) (0,1)

I_(P) 0.93 1.01 -0.04

(22.88) (14.42) (6.42)

AR Root 0.85 0.95 0.82 0.98 0.64 0.69 0.56 0.63 0.81 0.97 0.91 0.99 0.996 0.79 0.86

0.62 0.94 0.62 0.42 0.92 0.88 0.974

MA Root 0.99 0.99 0.99 0.964 0.99 0.99 0.99 0.99 0.99 0.9 0.91 0.99 0.99 0.99 0.46 0.974 1.00 0.99

0.98 0.804 0.99 0.95 0.99 0.99 0.87 0.93 0.86 0.763 0.76

P[QLB] 0.40 0.35 0.54 0.77 0.52 0.08 0.00 0.29 0.16 0.04 0.26 0.16 0.21 0.66 0.18 0.11 0.61 0.35

Table 2. Summary of the valid univariate ARIMA specification for OPEC Countries

Countrie Algeria Angola Nigeria Saudi Arabia Ecuado Kuwait

s r

Sample 1978Q1 1999Q2 1996Q1 2000Q4 1964Q1 1998Q4 1975Q1 1979Q3 1987Q1 1977q1

2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012q4

(140) (55) (68) (49) (196) (57) (152) (134) (104) (140)

Model ARIMAX R_SARIM R_A_SARIM R_A_ARIM ARIMAX R_SARIM R_A_SARIMA R_A_ARIM ARIMAX R_SARIM R_A_SARIM R_A_ARI ARIMAX R_SARIM R_A_SARIMA R_A_ARI ARIMAX ARIMAX

A A A A A A A MA A MA

ARMA (4,4) (1, 0) (1,0) (0, 3) (1, 2) (1, 3) (3,0) (1, 3) (1,2) (2, 0) (1,1) (0, 3) (1,4) (2,1) (2,1) (1, 4) (0,2) (1,3)

(1,0) (0,1) (0,1) (0,1) (1,0) (0,1) (1,0) (1,0) (0,1) (0,1)

I_(P) 0.93 0.22 0.41 0.59 0.25 0.57

(22.88) (65.17) (6.74) (10.88) (6.67) (21.04)

AR Root 0.93 0.99 0.98 0.70 0.81 0.99 0.98 0.98 0.81 0.76 0.73 0.98 0.98 0.91 0.98 0.35

0.86 0.87 0.65 0.57 0.88

MA Root 0.97 0.99 0.99 0.99 0.99 0.99 0.99 0.99 1.00 1.00 0.99 0.99 0.99 0.99 0.99 0.91

0.88 0.92 0.30 0.61 0.46 0.42 0.99 0.61 0.81 0.89 0.69 0.94

P[QLB] 0.06 0.43 0.73 0.61 0.11] 0.05 0.05 0.02 0.18 0.41 0.97 0.29 0.14 0.11 0.08 0.09 0.12 0.31

Where P[QLB]= Probability value of the Ljung-Box Q-statistic at that based on the square root of the sample size, AR Roots = Stationary Autoregressive average, MA Roots = Stationary Moving average, LR(SEA DUM) =

the joint test for the seasonal dummy variables, Rounded Bracket = T – Ratios and Square Bracket = Probability value. I_(P ) = is an index indicator variable for seasonal shifts embodied as the deterministic terms

is an index indicator variable for seasonal shifts embodied as the deterministic terms

10

The full sample univariate model that employs seasonal Box-Jenkins ARIMA techniques and model’s structural

breaks is denoted as ARIMAX. The full sample univariate model that employs Box-Jenkins ARIMA techniques

without modelling structural breaks is denoted as F_SARIMA (this model type is exclusive to India and China

because there were no significant structural breaks to model over the full sample for India, and the period after

the structural breaks are less than 39 observations for China. However, the breaks identified in China are relative

step shifts that appear to be small which mean that inference regarding unit roots may not be too adversely affected

when using the full sample. Hence, we considered the full sample for both China and India. The full sample

specifications that employ EViews 9’s automatic seasonal and non-seasonal ARIMA model without modelling

breaks are denoted as F_A_SARIMA and F_A_ARIMA respectively. The reduced sample model that employs

seasonal ARIMA technique’s without modelling structural breaks is denoted as R_SARIMA. The reduced sample

model that employs EViews 9’s automatic seasonal ARIMA model selection procedure without modelling breaks

is denoted as R_A_SARIMA and the reduced sample model that employs EViews 9’s automatic non-seasonal

ARIMA model selection method without modelling breaks is represented by R_A_ARIMA. F_TAR Model is

denoted as threshold autoregressive model estimated over the full sample and R_TAR model is denoted as the

threshold autoregressive model estimated over the reduced sample that avoid modelling breaks.

Table (1 and 2) above summarises the favoured different ARIMAX and ARIMA specifications

for all BRICS and OPEC countries. For ARIMAX model estimated over the full sample and

include deterministic model to capture the structural breaks, the indicator index of the

deterministic model (I_P) is significant for all the countries and none of the selected models

could be rejected for the standard diagnostic of residual autocorrelation, stationarity and

invertibility (see row labelled AR, Root, MA Root and P[QLB] in the table 1 and 2). For the

favoured ARIMA specifications over a reduced sample that design to avoid modelling breaks.

For seasonal ARIMA (R_SARIMA), none of the selected models could be rejected for the

standard diagnostic of residual autocorrelation, stationarity and invertibility. However, 4 of the

9 selected countries failed the standard diagnostic test for seasonal automatic selected models

(R_A_SARIMA) and (F_A_SARIMA). In particular, three of the 5 BRICS countries’

automatically selected models fail the standard diagnostic checks for autocorrelation (Russia

and India) and invertibility (South Africa). Only Nigeria failed the standard diagnostic checks

(for invertibility) in the selected OPEC countries. Where non-seasonal ARMA models

automatically developed (R_A_ARIMA), none of the automatically selected models could be

rejected for the standard diagnostic (residual autocorrelation, stationarity and invertibility) that

we conduct for the 5 BRICS countries. However, for 2 of the 4 selected OPEC countries the

automatically selected models failed the diagnostic checks for autocorrelation (Angola) and

invertibility (Nigeria). This implies that the automatic selection procedure often selects models

that failed the standard diagnostic or select variables that would be considered for exclusion by

a modeller. It will be interesting to see whether this has an impact on the forecasting

performance of these models.

11

Table 3. Summary of the valid TAR models for BRICS countries

Countries Brazil Russia India China South Africa

Full Reduce Full Reduce Full Full Full sample Reduce sample

sample sample sample sample sample sample

Sample 1984Q4 1997Q2 1996Q1 2003Q2 1961Q1 1992Q1 1961q1 1995q2-2012q4

2012q4 2012q4 2012q4 2012q4 2012q4 2012q4 2012q4

Lags values 3 3 6 2 5 10 6 6

Regimes 1 2 2 2 2 1 2 2

Threshold 0.07 0.24 0.08 0.11 0.85 0.11

value for 1 [41] (57] [32] [166] [160] [60]

value for 2 [22] [11] [32] [42] [48] [11]

LM[RESID] 0.09 0.99 0.08 0.39 0.07 0.18 0.13 0.77

LM 0.45 0.08 0.26 0.71 8.73 3.42

(Obs*R-

squared) 2.56 0.25

Where LM[RESID ()] = p value of the residual, LM (Obs*R-squared) = probability value of Breusch- Godfrey

LM test.

Table 4. Summary of the valid TAR models for selected OPEC countries

Countries Algeria Angola Nigeria Saudi Kuwait Ecuador

Arabia

Full Reduce Full Reduce Full Reduce Full Reduce

sample sample sample sample

sample sample sample sample

Sample 1978Q1 1999Q2 1996q1 2000Q4 1964q1 1998Q4 1975Q1 1979Q3 1977q1 1987q1

2012q4 2012q4 2012q4 2012q4 2012q4 2012q4

2012q4 2012q4 2012q4 2012q4

Lags values 7 5 3 2 15 6 10 8 5 3

Regimes 3 2 1 2 2 2 2 3 2 3

Threshold 0.09 0.01 1.12 0.37 0.15 0.05 0.004 0.06 0.44

value for 1 (83] [25] [19] [165] [24] [130] [51] [115] [72]

Threshold 0.09 0.01 1.12 0.38 0.15 0.05 0.004 0.06 0.44

value for 2 [24] [30] [30] [28] [33] [22] [63] [29] [15]

value for 3 [33] [20] [17]

LM[RESID] 0.32 0.16 0.11 0.05 0.25 0.39 0.16 0.31 0.18 0.97

LM 0.21 0.35 0.08 0.05 0.95 0.26 0.27 0.56

(Obs*R- 0.81

squared) 0.12

Where LM[RESID ()] = p value of the residual, LM (Obs*R-squared) = probability value of Breusch- Godfrey

LM test.

Table (3 and 4) above summarised the favoured TAR model estimated over the full sample a

reduced sample that avoid that avoid modelling breaks. For both BRICS and OPEC countries,

we noticed that the TAR specifications estimated over the full sample identified at least two

regimes for all selected countries except China and Brazil for BRICS countries and only

Angola for OPEC countries. Whereas, the TAR model estimated over the reduced sample

identified minimum of two regimes for all selected countries for both BRICS and OPEC

countries. We also noticed all the estimated TAR models passed the diagnostic test for both

series (LM (Obs*R-squared) and residual autocorrelation (LM[RESID]. This result implies

that regime shift TAR model is appropriate to model and forecasting inflation in most of the

selected countries.

12

6. Forecast performance and evaluation

In this section, we estimate a benchmark model (naïve model) for annual inflation and compare

its forecasting performance with different univariate ARIMA/ARIMAX and regime shift

threshold model estimated over the full sample and reduced sample in table 1,2, 3 and 4 to

choose the best model that forecasts inflation in each country. Each model is estimated over a

period that ended in 2012q4 (the start of the estimation period varies across models and

countries). These models are used to produce forecasts over the ex-post forecasting period

2013q1 – 2014q4. These produce 1-step ahead forecasts for 2013q1, 2-step ahead forecasts for

2013q2 and so on up to 8-step ahead forecasts for 2014q4. The identified models were then re-

estimated by adding one observation to the end of the sample, hence the models are estimated

over a period ending in 2013q1. These estimated models are used to produce 1-step ahead

forecasts for 2013q2, 2-step ahead forecasts for 2013q3 and so on up to 7-step ahead forecasts

for 2014q4. This process is then repeated with one observation being added to the estimation

period (with the last rolling regression’s sample period ending in 2014q3), and m-step ahead

forecasts produced up to the end of the forecast period. These rolling regressions produce eight

1-step ahead forecasts, seven 2-step ahead forecasts, six 3-step ahead forecasts, five 4-step

ahead forecasts and so on up to one 8-step ahead forecast for each estimated model. Further,

we compare the forecasting performance of each model over the different number of step ahead

forecasting horizons using the Root Mean Squared Error (RMSE), Mean Absolute Percentage

Error (MAPE) and Theil’s inequality coefficient (U). The best forecasting model, on average,

over any particular horizon will have the lowest value of forecasting performance measures.

The summary of the best forecasting performance measures of each country are given in Table

(5 and 6).

13

5. Summary of the best forecasting univariate models for BRICS countries

RMSE6

Brazil

2_step 3_step 4_step 5_step 6_step 7_step 8_step

ARIMAX 24.352 26.422 28.943 32.364 37.365 19.135 14.919

R_SARIMA 0.006 0.008 0.006 0.004 0.005 0.01 0.002

R_A_SARIMA 0.006* 0.006 0.006 0.007 0.006 0.006 0.009

R_A_ARIMA 0.007 0.006* 0.003* 0.0002* 0.0004* 0.0004* 0.0004*

F_TAR 0.017 0.026 0.031 0.036 0.039 0.042 0.042

R_TAR 0.008 0.011 0.011 0.008 0.004 0.007 0.006

Navie 0.006 0.006 0.004 0.002 0.007 0.008 0.002

Russia

ARIMAX 0.031 0.034 0.046 0.036 0.035 0.032 0.017

R_SARIMA 0.018 0.022 0.023 0.022 0.024 0.026 0.011

R_A_SARIMA 0.028 0.04 0.053 0.056 0.049 0.048 0.029

R_A_ARIMA 0.008* 0.015* 0.016* 0.016* 0.014* 0.016* 0.006*

F_TAR 0.658 0.888 1.067 1.214 1.333 1.43 1.509

R_TAR 0.049 0.078 0.206 0.543 1.077 1.964 4.156

Navie 0.084 0.114 0.203 0.368 0.599 0.991 2.039

China

F_SARIMA 0.01 0.015 0.021 0.025 0.028 0.028 0.031

F_A_ARIMA 0.009 0.015 0.023 0.026 0.039 0.028 0.028

F_TAR 0.005* 0.008* 0.010* 0.012* 0.014* 0.015* 0.011*

Navie 0.026 0.037 0.047 0.057 0.068 0.078 0.105

India

F_A_SARIMA 0.018 0.019 0.023 0.020 0.022 0.024 0.030

F_SARIMA 0.011* 0.019* 0.020* 0.020* 0.021* 0.020* 0.020*

F_TAR 0.023 0.021 0.021 0.021 0.021 0.021 0.034

Navie 0.047 0.057 0.076 0.088 0.102 0.130 0.207

South Africa

ARIMAX 0.051 0.056 0.051 0.043 0.043 0.052 0.051

R_SARIMA 0.023 0.026 0.021 0.012* 0.012 0.012 0.006*

R_A_SARIMA 0.012* 0.013* 0.015* 0.014 0.009* 0.008* 0.012

R_ARIMA 0.059 0.055 0.047 0.023 0.015 0.031 0.021

F_TAR 0.024 0.025 0.038 0.046 0.050 0.049 0.123

R_TAR 0.016 0.021 0.029 0.031 0.031 0.034 0.043

Navie 0.020 0.037 0.047 0.057 0.068 0.078 0.105

6

We only report the result of RMSE in this table because result produced by the MAPE and U statistics are

similar.

14

6.Summary of the best forecasting univariate models for OPEC countries

RMSE

Angola

R_ARIMA 0.067 0.145 0.179 0.191 0.243 0.281 0.113 0.154

Algeria

F_TAR 0.017 0.027 0.036 0.042 0.044 0.035 0.023 0.019

R_TAR 0.016 0.018 0.024 0.031 0.031 0.026 0.021 0.018

Navie 0.033 0.051 0.063 0.078 0.088 0.091 0.083 0.043

Saudi Arabia

R_TAR 0.003 0.005 0.005 0.007 0.009 0.010 0.011 0.012

Nigeria

ARIMAX 0.025 0.044 0.066 0.078 0.086 0.091 0.099 0.123

R_SARIMA 0.017 0.028 0.040 0.046 0.047 0.044 0.043 0.041

R_A_ARIMA 0.024 0.038 0.031 0.032 0.038* 0.035* 0.036* 0.040*

R_A_ SARIMA 0.023 0.027 0.041 0.037 0.058 0.045 0.048 0.045

F_TAR 0.032 0.051 0.056 0.051 0.043 0.043 0.052 0.051

Navie 0.042 0.062 0.086 0.107 0.125 0.148 0.183 0.256

Ecuador

Navie 0.111

0.030 0.031 0.031 0.031 0.029 0.027 0.013

Kuwait

ARIMAX 0.006* 0.009* 0.013* 0.010* 0.012* 0.011* 0.008* 0.004*

F_TAR 0.007 0.012 0.013 0.011 0.013 0.014 0.009 0.007

Navie 0.025 0.027 0.031 0.032 0.032 0.034 0.036 0.039

15

7. Empirical Results and Discussion

For BRICS countries, see Table 5, the EViews 9 automatic model selection procedure is

virtually always favoured for all countries except India and China. The reduced sample

automatic seasonal method is favoured for Brazil over the 1 and 2 steps ahead horizons and for

South Africa over the 1 to 4 and 6 to 7-step ahead horizons. The reduced sample automatic

non-seasonal method is favoured for Brazil over the 3 to 8 step horizons and for Russia over

all horizons. The seasonal ARIMA model (without modelling structural breaks) is favoured for

India over all horizons (using the full sample) and is preferred for South Africa over the 5 and

8 step horizons (using a reduced sample). The benchmark model (naïve model) and ARIMAX

model were never favoured for any BRICS countries. The threshold autoregressive model

(using full sample) only favoured for China over all forecasting horizons. In contrast, the

threshold autoregressive model estimated over a reduced sample were never favoured for any

of the BRICS countries.

For OPEC countries, see Table 6 the EViews 9 automatic model selection procedure applied

to the reduced sample is only occasionally favoured and the automatic seasonal method is never

favoured for all forecasting horizons (which contrasts with the results for BRICS countries).

The automatic non-seasonal method is favoured for Algeria over the 2-step horizon, for Saudi

Arabia over the 4 to 8 steps ahead horizons and for Nigeria over 5 to 8 step horizons. The

seasonal ARIMA model (without modelling structural breaks) is favoured for Angola over all

horizons. The ARIMAX model produce a better forecast over all forecasting horizons for

Ecuador, Kuwait and Algeria. The exception is for Algeria over 2-step ahead forecast. The

nonlinear TAR models were not favoured over the best selected linear ARIMA/ARIMAX for

OPEC countries except for Nigeria (over 1 to 4-steps ahead horizons) and Saudi Arabia (over

1 to 3- steps ahead) using a reduced sample and full sample respectively. For all the OPEC

countries, the naïve model was never favoured.

The main conclusion from this table (5 and 6) is that there is no single model that dominates

across all the countries and the best forecasting method varies considerably across the models.

However, the following general findings can be useful for future research. First, when

comparing model estimated over the full sample (ARIMAX and F_TAR model) to the model

estimated over a reduced sample that avoid modelling breaks (e.g. R_ARIMA, R_A_SARIMA

and R_TAR model). The model estimated over the full sample is rarely favoured except for

Kuwait and Ecuador where we only estimated for full sample and Algeria over all forecasting

horizon. For the favoured reducing sample model, the EViews 9’s automatic model selection

procedure is often favoured (especially for the BRICS countries) although seasonal ARIMA

modelling without using automatic model selection is sometimes favoured. Hence, the quick

automatic ARIMA selection procedures often (though not always) produce superior forecasts

compared to more time-consuming Box-Jenkins ARIMA modelling techniques. Of the two

automatic ARIMA model selection procedures considered the non-seasonal method applied to

seasonally adjusted data was more generally favoured than the seasonal method applied to

16

unadjusted data. This suggests that the benefit of seasonally adjusting the data and re-

seasonalising the forecasts generally outperforms the method of explicitly modelling

seasonality. We also noticed that the nonlinear TAR models were not favoured over the best

selected models for BRICS and OPEC countries except for Nigeria (over 1 to 4 steps ahead),

Saudi Arabia (over 1 to 3 steps ahead horizon) and China (over all forecasting horizons).

Hence, there are 3 countries where the TAR model produces the better forecasts than the best

selected univariate ARIMA/ARIMAX specifications over at least some horizons. Lastly, our

study also revealed that the benchmark model (naïve forecast) were never favoured over the

best selected model for BRICS and OPEC countries. This evidence confirmed that using

univariate ARIMA/ARIMAX and TAR models were the better strategies for forecasting

inflation for BRICS and OPEC countries. Our result is consistent with studies of Atkeson and

Ohanian (2001) who argued that an inflation forecasting cannot be considered a useful guide

for policy if its forecasting performance is not better than a simple naïve model.

In this research, we estimate a benchmark model (naïve model) and compare its forecasting

performance with the best selected univariate ARIMA/ARIMAX specification and nonlinear

TAR model. In particular, we produce forecasts for ARIMAX models that have a deterministic

component to account for structural breaks over the full sample period and different ARIMA

specifications over a reduced sample period that avoids structural breaks. The ARIMA models

that we develop over the reduced sample period are, first, a seasonal ARIMA specification

identified using the Box-Jenkins method, second, a seasonal ARIMA model identified using

EView’s automatic model selection tool and, third, a non-seasonal ARIMA model identified

using EView’s automatic model selection tool applied to seasonally adjusted data. For

nonlinear TAR model, the model is estimated over the full sample and reduced sample that

designed to avoid modelling breaks.

From our study, the following conclusions emerge: First, ARIMAX and TAR model that passes

standard diagnostic checks for residual autocorrelation, stationarity and invertibility can be

obtained in all selected countries. Second, when comparing model estimated over the full

sample to the model estimated over a reduced sample that avoids modelling structural breaks,

the model estimated over a reduced sample often exhibit superior forecasting performance

compared to the selected models estimated over the full sample in most countries except for

Algeria. This result is consistent with the notion that models with many regressors, as required

when modelling structural breaks, can overfit the sample and exhibit a poor forecasting

performance (Yohei, 2013 and Carlos, 2014). Third, ARIMA specifications based upon the

EViews 9 automatic model selection procedure are virtually favoured for BRICS countries. For

instance, the EViews 9 automatic model selection procedure is favoured over the seasonal Box-

Jenkins ARIMA model (that does not use the automatic selection technique) for all BRICS

countries except India and China. In contrast, the EViews 9 automatic model selection models

were never favoured for OPEC countries except for Saudi Arabia (over 4 to 8 steps ahead) and

17

Nigeria (over 5 to 8 steps ahead). The performance of the EView automatic selected model for

BRICS countries suggests that automatic selection methods not only have the benefit of saving

time they often also produce superior forecasts. This is despite our finding that ARIMA models

based on automatic selection procedures often fail standard diagnostic checks and/or include

irrelevant regressors. Fourth, when comparing automatic ARIMA model selection

specifications that explicitly model seasonality to those that apply non-seasonal models to

seasonally adjusted data and re-seasonalize the forecasts. We observed that building ARIMA

models to seasonally adjusted data and re-seasonalising the forecasts generally yields superior

forecasting performance relative to constructing seasonal ARIMA models when using

automatic ARIMA model selection procedures. Our result also shows that the benchmark

models (naïve forecast) were never favoured over the best selected ARIMA/ARIMAX and

TAR model for BRICS and OPEC countries. Similarly, the nonlinear TAR models were rarely

favoured over the best selected univariate ARIMA/ARIMAX model for BRICS and OPEC

countries except for Nigeria (over 1 to 4 steps ahead), Saudi Arabia (over 1 to 3 steps ahead

horizon) and China (over all forecasting horizons). Hence, there are 3 countries where the TAR

model produces the better forecasts than the best selected univariate ARIMA/ARIMAX

specifications over at least some horizons. The performance of the TAR model for China,

Nigeria and Saudi Arabia over the few steps are consistent with the studies of Montgomery, et

al. (1998), Tiao and Tsay, (1991), Clements and Smith (1997)., Pippenger and Goering, (1998)

who document that good performance of TAR model over other selected univariate model most

especially during the period of economic recession.

18

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