, Volume 20, Issue 2, pp 265-291

Testing a Model of the UK by the Method of Indirect Inference

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Abstract

We use the method of indirect inference to test a full open economy model of the UK that has been in forecasting use for three decades. The test establishes, using a Wald statistic, whether the parameters of a time-series representation estimated on the actual data lie within some confidence interval of the model-implied distribution. Various forms of time-series representation that could deal with the UK’s various changes of monetary regime are tried; two are retained as adequate. The model is rejected under one but marginally accepted under the other, suggesting that with some modifications it could achieve general acceptability and that the testing method is worth investigating further.

We are grateful for useful comments to James Davidson, Bernard Pearson and Simon Wren-Lewis; also to Mike Wickens for discussions over a long period. This paper was written before Theodoridis joined the Bank of England. The views expressed in this paper are those of the authors, and not necessarily those of the Bank of England.