Forecasting Euro-Area Macroeconomic Variables Using a Factor Model Approach for Backdating

Abstract

We suggest to use a factor model based backdating procedure to construct historical Euro-area macroeconomic time series data for the pre-Euro period. We argue that this is a useful alternative to standard contemporaneous aggregation methods. The paper investigates for a number of Euro-area variables whether forecasts based on the factor-backdated data are more precise than those obtained with standard area-wide data. A recursive pseudo-out-of-sample forecasting experiment using quarterly data is conducted. Our results suggest that some key variables (e.g. real GDP, inflation and long-term interest rate) can indeed be forecasted more precisely with the factor-backdated data.