A Novel Approach to Forecasting After Large Forecast Errors

Abstract:

A sequence of increasingly large same-sign 1-step-ahead forecast errors are most likely due to a sudden unexpected shift. Large forecast errors can be expensive, but also contain valuable information. Impulse indicators acting as intercept corrections to set forecasts back on track can be quickly tested for replacing outliers, a location shift or broken trend, greatly improving forecast accuracy. The analysis is applied to forecasting the UK's annual consumer price inflation which rose rapidly from mid-2021 to over 9% in 2022 after a series of essentially unpredictable shocks led to large forecast errors by the Bank of England.