| Abstract: | Summary The German economy is usually assumed to take a leading position. In principle this gives smaller countries, which are dependent on Germany, the opportunity to predict their own economic future conditional on the state of the German economy. This paper uses this opportunity for The Netherlands by applying a Vector Auto Regressive model on Dutch and German series. Because the traditional VAR models appear to be overparameterized, their forecast performance can be improved significantly by using shrinkage estimators based on the so-called Minnesota prior. Such a Bayesian VAR forecasts well and confirms the interdependence between Germany and The Netherlands. Variance decomposition of forecast errors and impulse response simulations strengthen the impression that the BVAR model properties are plausible.The author works at the Econometric Research and Special Studies Department of the Nederlandsche Bank. He is grateful to M.M.G. Fase, C.C.A. Winder and two anonymous referees for their useful comments and to R.B.M. Vet for his assistance in various calculations. |
