Neural Network versus Econometric Models in Forecasting Inflation

Artificial neural network modeling has recently attracted much attention as a new technique for estimation and forecasting in economics and finance. The chief advantages of this new approach are that such models can usually find a solution for very complex problems, and that they are free from the assumption of linearity that is often adopted to make the traditional methods tractable. In this paper we compare the performance of Back-Propagation Artificial Neural Network (BPN) models with the traditional econometric approaches to forecasting the inflation rate. Of the traditional econometric models we use a structural reduced form model, an ARIMA model, a vector autoregressive model, and a Bayesian vector autoregression model. We compare each econometric model with a hybrid BPN models which uses the same set of variables. Dynamic forecasts are compared for three different horizons: one, three and twelve months ahead. Root mean squared errors and mean absolute errors are used to compare quality of forecasts. The results show the hybrid BPN models able to forecast as well as all the traditional econometric methods, and to outperform them in some cases.

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