Brazilian Review of Econometrics V 36, N 2, P 223-254, 2016

Gabriel Vasconcelos, Eduardo H. de Freitas, Marcelo Medeiros.

In this paper we use high-dimensional models, estimated by the Least Absolute Shrinkage and Selection Operator (LASSO), to forecast the Brazilian inflation. The models are compared to  benchmark specifications such as linear autoregressive (AR) and the factor models based on principal components. Our results showed that the LASSO-based specifications have the smallest errors for short-horizon forecasts. However, for long horizons the AR benchmark is the best model with respect to point forecasts. The factor model also produces some good long horizon forecasts in a few cases. We estimated all the models for the two most important Brazilian inflation measures, the IPCA and the IGP-M indexes. The results also showed that there are differences on the selected variables for both measures. Finally, the most important variables selected by the LASSO based models are, in general, related to government debt and money. On the other hand, variables such as unemployment and production were rarely selected by the LASSO.