Forecasting in the presence of large shocks

Nelson and Plosser (1982) argued that the trend in many macroeconomic time series changes frequently. Perron (1989), Rappoport and Reichlin (1989), and Balke and Fomby (1991), on the other hand, presented models that say changes in trend occur only relatively rarely. This paper provides a model that can account for evidence like that presented by Perron, Rappoport and Reichlin, and Balke and Fomby while being consistent with Nelson and Plosser's hypothesis of frequent shifts in trend. The paper gives methods for estimating the model, and it shows how estimates of the model's parameters can be used to construct parametric bootstrap forecast intervals. These methods are applied to the extended Nelson-Plosser data set used by Schotman and van Dijk (1991).