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Forecasting Canadian money supply growth using univariate arima and multivariate vector arma models

The money supply growth ;ate is a vital financial variable in any economy. Given its importance, a relevant question is whether or not money supply growth rate can be adequately predicted by professionals outside the Bank of Canada. The objective of this paper is to deal with this question in the Canadian context. We examine how univariate ARIMA and multivariate vector ARMA models can be applied to forecasting the Canadian money supply growth rate. An attempt is made to assess the relative efficacy of our two models' predictive performances. In addition, the roles of the unemployment rate, inflation rate, nominal interest rate, and exchange rate in the determination of the money supply by the Bank of Canada are examined in application of the vector ARMA model. In constructing our univariate ARIMA and multivariate vector ARMA models, an iterative three-stage procedure which includes model identification, model estimation and diagnostic checks on model adequacy, is used. Univariate ARIMA models rely only upon a series' past statistical characteristics to infer its future movements. Because only one time series is involved in univariate ARIMA models, the problem of finding explanatory variables in conventional regression analysis can be avoided. Multivariate vector ARMA models, which can be viewed as a set of reduced form equations associated with a simultaneous system of structural linear equations, allow whatever causal relationships that exists among the variables under study to emerge from the data; no a p r i o r i directional or causal constraints are imposed on the relationships. Hence, the problem involving choice of appropriate lag structures in conventional regression analysis can be avoided. The results show that our chosen multivariate vector ARMA model generates more accurate long term forecasts than the univariate ARIMA models. Also, the results from the vector ARMA model reflect high correlation of the money supply growth rate with the nominal interest rate, exchange rate and inflation rate. The unemployment rate, however, is not significantly correlated with the money supply growth rate. This result suggests that the Bank of Canada had not paid much attention to unemployment in its management of the money supply during the period of analysis. Instead, the concern of the Bank has been to manage the money supply to control inflation.