Part A

Inflation formula:

Annualised inflation as percentage=100

12 ( CPI t CPI t 1)
CPI t 1

Where t =1 month
Equation 1

Part i:
Using equation 1, the mean of inflation is 4.42%

Part ii:
Yes, there is persistence in inflation. The following ACF plot (Figure 1) shows
autocorrelation which rejects the null of no autocorrelation at the 5% level (as
shown in blue). Further, the plot shape of the ACF may indicate a seasonal trend.

Figure 1

Part B
Box-Ljung test of independence in time series:
The following table depicts the lag tested in the Box-Ljung test, null hypothesis
for the test, alternative hypothesis, test statistic distribution, sample value,
critical value and conclusion. The function of the test statistic is given by Equation
2, where s is both the number of lags and restrictions.

^2j
j=1 (T j)
s

Qs=T (T +2)

Equation 2

La
g

H0

HA

1=0

1 0

1=2 =0

i : i 0

1=2 =3=0

i : i 0

1=2 =3= 4=0

i : i 0

S in
test
statis
tic

Test
statistic
distributio
n

Samp
le
value

95%
critic
al
value

2 (1)

94.29

3.84

2 (2)

153.7
9

5.99

2 (3)

218.0
5

7.81

2 (4 )

274.2
6

9.49

Part C
Part i:
The following table shows inflation models AR(1)-AR(6). For each model, the
table shows the AIC, BIC, presence of autocorrelation in errors (as determined by
a Box-Ljung test with lag=36 and p-value at most 0.05) and significance of the
time trend (as determined by the p-value of the time variable t-test not
exceeding 0.05).
Model

AIC

BIC

Autocorrelated
errors

Time trend
significant

AR(1)

4.639865

4.695877

yes

yes

AR(2)

4.645269

4.719952

yes

yes

AR(3)

4.616537

4.709890

yes

yes

AR(4)

4.628457

4.740480

yes

yes

AR(5)

4.616126

4.746821

yes

yes

AR(6)

4.593546

4.742911

yes

yes

Part ii:
The BIC suggests that the AR(1) model is the best fit as it is the minimal BIC
value.

Part iii:
The AIC prefers the AR(6) model as it minimises the AIC value.

Conclusi
on
Reject

H0
Reject

H0
Reject

H0
Reject

H0

Part D
Part i:
To estimate a different intercept and time trend in the model, a structural break
dummy must be constructed. Denoting this structural break dummy variable as

d SB , Equation 3 shows how it is derived:

d SB = 0 if date 1986
1 if date<1986
Equation 3

This dummy will estimate the difference in intercepts. To estimate the difference
in time tends,

d SB

is interacted with the time trend as shown in Equation 4:

time SB=d SB time

Equation 4

Estimating the structural break in this way evaluates the period 1986 onwards as
a baseline and the pre-1986 period as a difference. The dummy and interacted
time trend have been constructed this way because the high inflation of the
1980s are considered an anomaly, not the typical macroeconomic trend. Given
these new variables, an AR(1) model (as selected by minimal BIC) with a
structural break can be represented by Equation 5:

yf t = 0+ 1 time+ 2 d SB+ 3 time SB + 4 yf t 1

Equation 5

Part ii:

01/02/1982 Time 01/ 12/1995 , Equation 6 shows estimated parameter

Where
values:

^
yf t =3.0753170.00974 time+ 6.480543 d SB0.107256 ( d SB time ) +0.249993 yf t1
(0.813261 )

( 0.006142)

( 1.400712)

( 0.02778 )

( 0.075982 )

Equation 6

In the estimated model, all estimates except for the time trend variables are
significant to the 5% level. Additionally, the model has an

value of

0.542824 and an F-statistic of 48.08741. Brackets under coefficient estimates

are standard error, not t-statistics.

Part iii:

Before the structural break, the intercept of inflation is estimated to be

6.480543% higher than after the break.

Part iv:
Before the structural break, time is expected to have a -0.107256% effect on
inflation (where this effect is in addition to the overall time trend).

Part v:
The change in the marginal time trend is expected as before the structural break,
inflation was decreasing from a peak in the early 80s. After the structural break,
time does not have a large effect on inflation because it presumably trends
towards a long run mean.

Part E
To test the existence of a structural break, an F-test can be used to evaluate an
unrestricted model against a model which imposes equal parameter values
before and after the suggested structural break. The F-test will evaluate the
hypotheses in Equation 7, where beta parameters are those listed in Equation 5.

H 0 : 2= 3 =0

H A : j 0 for at least one j=2, 3

Equation 7

Estimating both restricted and unrestricted models, the following results are
found:
Result/para
meter

Value

R2ur

0.5267

R2r

0.4662

167

Given the results and parameters found, the F-statistic is derived in Equation 8:

(R2ur R 2r )/q
F=
(1R2ur )/(T k1)

(0.52670.4662)/2
(10.5267)/( 16751)

10.28998

Equation 8

The distribution of the test statistic under the null is F distribution. As the critical
value for the

F2,161

distribution at the 5% level is 3.052172, the null hypothesis

is rejected. This indicates that the structural break exists.

Part F
Part i:

yf t = 0+ 1 time t + 1 yf t1+ 2 yf t 2+ 3 yf t 3 + 4 yf t 4 + 5 yf t5 + 6 yf t6 + 7 yf t12+ ut

Regression results for the estimated model can be found in appendix 1. What is
most interesting about the regression is that the 12 th lag is significant to the 1%
level but other lags (such as the 5th or 6th) are not. This result likely indicates a
high degree of seasonality. Given that the data has a monthly resolution, the 12 th
lag will be the same time in the previous year; a period with the same seasonal
factors.

^
yf t =1.5871230.007166 time t + 0.420677 yf t10.197768 yf t2+ 0.139047 yf t3 0.045418 yf t4 + 0.05440
(1.004650)

( 0.006263 )

( 0.075119 )

( 0.081506 )

( 0.083326 )

( 0.081706)

Part ii:
Using a F-test to test the joint significance of the regressors time, the 3rd 4th 5th
6th lags. The F-test will evaluate the hypotheses in Equation 7, where beta
parameters are those listed in Equation 5.

H 0 : 1= 3= 4= 5= 6=0

H A : 1 0 j 0 for at least one j=3,4,5,6

Estimating both restricted and unrestricted models, the following results are
found:
Result/para
meter
2

Value

Rur

0.5647

R2r

0.5303

167

Given the results and parameters found, the F-statistic is derived in equation
below:

( 0.081672

(R2ur R 2r )/q
F=
(1R2ur )/(T k1)

(0.56470.5303)/5
(10.5647)/( 16781)

2.49722

Decision rule: Reject the null hypothesis if F calc>F Crit

The distribution of the test statistic under the null is F distribution. As the critical
value for the

F5,158

distribution at the 5% level is 2.21, the null hypothesis is

rejected. This indicates that at least one of the regressors which were individually
insignificant when use t-test is significant.
Part iii:
Decision rule: Reject the null hypothesis if F calc>F Crit.
The result is different if we test at the 1% significance level. As the critical value

F5,158

for the

distribution at the 1% level is 2.02, the null hypothesis cannot be

rejected. This indicates that we do not have 99% confidence that there is one
regressor in the restriction being significant.

Part G
Regression results for the estimated model can be found in appendix 1.

^
yf t =0.619722 +0.425136 yf t 1 0.109659 yf t2 +0.174807 yf t 6+ 0.271763 yf t12
(0.304127)

( 0.071583 )

( 0.071095)

( 0.066607 )

( 0.060366)

^
yf t =0.527105 +0.374830 yf t 1+0.161937 yf t6 +0.252369 yf t 12
(0.299399)

( 0.063990 )

( 0.066361)

( 0.059291 )

Part i:
Model (2) whose AIC is 4.524140 is selected by the AIC.
Part ii:
Model (3) whose BIC is 4.601426 is selected by the BIC.

Part H
If the error term in

yf t = 0+ 1 yf t 1 + 2 yf t6 + 3 yf t12+ e t
is autocorrelated of order 4, then

e t= 0+ 1 e t 1 + 2 e t2 + 3 et 3 + 4 e t4 + v t
So we run the Breusch-Godfrey Test by estimating equation

e^t= 0 + 1 yf t1+ 2 yf t 6+ 3 yf t 12 + 1 et 1+ 2 e t 2 + 3 e t3 + 4 et 4 +v t

(3)

(2)

Then

H 0 : 1=2=3 =4 =0

H A : j 0 for at least one j=1,2,3,4

The test statistic under the null is

as

BG =(T q) R2u^ 2 (q) where Eviews reports

BG =TR2u^

Or we can use a F-test test the joint significance where

H A : j 0 for at least one j=1,2,3,4

2

F=

( Rur R r )/q
F q ,T k1
2
(1Rur )/(T k1)

H 0 : 1=2=3 =4 =0

Estimating both restricted and unrestricted models, the following results are
found, and the test result can be found in Appendix 2
Result/para
meter

Value

167

Obs*Rsquared

8.367070

F-statistic

2.096608

As the critical value for the

the critical value for the

(4 ) distribution at the 5% level is 9.48773, and

F 4,159 distribution at the 5% level is 2.37, null

hypothesis cannot be rejected. This indicates that the error term is

autocorrelated of order 4 at 5% level.

Part I
Part i:
Using equation (3) to compute point forecasts of yfr the first six months of 1996

^
yf t =0.527105 +0.374830 yf t 1+0.161937 yf t6 +0.252369 yf t 12
(0.299399)

( 0.063990 )

( 0.066361)

1996M01

1.403079

1996M02

3.022097

1996M03

3.174689

1996M04

2.162573

1996M05

2.054875

1996M06

1.470207

( 0.059291 )

(3)

Part ii:
Using equation (2) to compute point forecasts of yfr the first six months of 1996

^
yf t =0.619722 +0.425136 yf t 1 0.109659 yf t2 +0.174807 yf t 6+ 0.271763 yf t12
(0.304127)

( 0.071583 )

( 0.071095)

1996M01

1.467883

1996M02

3.249396

1996M03

3.473238

1996M04

2.220184

1996M05

1.955471

( 0.066607 )

( 0.060366)

(2)

1996M06

1.394211

Part iii:
The forecast evaluation output can be find in the appendix 3.
Using criterion shown in the table to compare the precision of the forecasts.
Model
number

Model
chosen by

Criterion

Value

BIC

RMSE

2.101947

AIC

RMSE

1.962563

BIC

MAPE

60.89712%

AIC

MAPE

58.86820%

Form the result we preferred equation 2 which is the model chosen by AIC.
Part iv:
A 95% forecast interval for yf for January 1996 is given by

F1996 M 01 1.96 SEF 1996 M 01

Where

F1996 M 01=1.467883

and

SEF 1996 M 01= 2.324808, by the forecast output

as shown in appendix 3.
Then

P [1.4678831.96 ( 2.324808 )< F 1996 M 01 <1.467883+1.96 ( 2 .324808 ) ]=0.95

The 95% forecast interval for yf for January 1996 is

[3.08874, 6.024507]

Appendix 1: Regression results

Question F - part i model estimation
Dependent Variable: YF
Method: Least Squares
Date: 10/12/16 Time: 19:52
Sample: 1982M02 1995M12
Included observations: 167
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
TIME
YF(-1)
YF(-2)
YF(-3)
YF(-4)
YF(-5)
YF(-6)
YF(-12)

1.587123
-0.007166
0.420677
-0.197768
0.139047
-0.045418
0.054403
0.113165
0.218035

1.004650
0.006263
0.075119
0.081506
0.083326
0.081706
0.081672
0.076584
0.065513

1.579777
-1.144154
5.600164
-2.426417
1.668699
-0.555872
0.666109
1.477658
3.328113

0.1162
0.2543
0.0000
0.0164
0.0972
0.5791
0.5063
0.1415
0.0011

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.564654
0.542611
2.279035
820.6519
-369.9035
25.61619
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

3.860508
3.369830
4.537767
4.705802
4.605969
1.950923

Question G - model estimation

Dependent Variable: YF
Method: Least Squares
Date: 10/12/16 Time: 20:01
Sample: 1982M02 1995M12
Included observations: 167
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
YF(-1)
YF(-2)
YF(-6)
YF(-12)

0.619722
0.425136
-0.109659
0.174807
0.271763

0.304127
0.071583
0.071095
0.066607
0.060366

2.037712
5.939084
-1.542435
2.624451
4.501959

0.0432
0.0000
0.1249
0.0095
0.0000

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.549472
0.538348
2.289630
849.2696
-372.7657
49.39461
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

3.860508
3.369830
4.524140
4.617493
4.562030
1.935324

Dependent Variable: YF
Method: Least Squares
Date: 10/12/16 Time: 20:03
Sample: 1982M02 1995M12
Included observations: 167
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
YF(-1)
YF(-6)
YF(-12)

0.527105
0.374830
0.161937
0.252369

0.299399
0.063990
0.066361
0.059291

1.760547
5.857624
2.440235
4.256464

0.0802
0.0000
0.0157
0.0000

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.542856
0.534442
2.299295
861.7418
-373.9831
64.52054
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

3.860508
3.369830
4.526743
4.601426
4.557055
1.871606

Appendix 2: Breusch-Godfrey Test results

Question H
Breusch-Godfrey Serial Correlation LM Test:
F-statistic
Obs*R-squared

2.096608
8.367070

Prob. F(4,159)
Prob. Chi-Square(4)

0.0837
0.0790

Test Equation:
Dependent Variable: RESID
Method: Least Squares
Date: 10/12/16 Time: 20:12
Sample: 1982M02 1995M12
Included observations: 167
Presample missing value lagged residuals set to zero.
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
YF(-1)
YF(-6)
YF(-12)
RESID(-1)
RESID(-2)
RESID(-3)
RESID(-4)

-0.012858
0.001545
-0.004213
0.005174
0.090833
-0.213936
0.072021
-0.028276

0.340664
0.128071
0.071790
0.067407
0.149955
0.091454
0.080800
0.081613

-0.037743
0.012066
-0.058686
0.076762
0.605735
-2.339271
0.891339
-0.346463

0.9699
0.9904
0.9533
0.9389
0.5456
0.0206
0.3741
0.7295

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.050102
0.008283
2.268968
818.5666
-369.6911
1.198062
0.306877

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

1.17E-15
2.278424
4.523246
4.672611
4.583870
1.997407

Appendix 3: Forecast Evaluation Output

Question I Model chosen by BIC
10

Forecast: FORE_I_I
Actual: YF
Forecast sample: 1996M01 1996M06
Included observations: 6
Root Mean Squared Error 2.101947
Mean Absolute Error
1.474072
Mean Abs. Percent Error
60.89712
Theil Inequality Coefficient 0.342100
Bias Proportion
0.085841
Variance Proportion
0.808167
Covariance Proportion 0.105992

8
6
4
2
0
-2
-4
M1

M2

M3

M4

M5

M6

1996
FORE_I_I

?2 S.E.

Question I Model chosen by BIC

10

Forecast: FORE_I_II
Actual: YF
Forecast sample: 1996M01 1996M06
Included observations: 6
Root Mean Squared Error
1.962563
Mean Absolute Error
1.389134
Mean Abs. Percent Error
58.86820
Theil Inequality Coefficient
0.313625
Bias Proportion
0.074877
Variance Proportion
0.810366
Covariance Proportion
0.114756

8
6
4
2
0
-2
-4
M1

M2

M3

M4

M5

1996
FORE_I_II

?2 S.E.

Question I SEF of forecast by model chosen by AIC

Date
1996M01
1996M02
1996M03
1996M04
1996M05
1996M06

Sef
2.324808
2.511093
2.508082
2.509592
2.508517
2.510667

M6