Title: The macroeconomy as a random forest
Authors: Philippe Goulet Coulombe - University of Pennsylvania (United States) [presenting]
Abstract: Over the last decades, an impressive amount of nonlinearities have been proposed to reconcile reduced-form macroeconomic models with the data. Many of them boil down to have linear regression coefficients evolving through time: threshold/switching/smooth-transition regression; structural breaks and random walk time-varying parameters. While all of these schemes are reasonably plausible in isolation, we argue that those are much more in agreement with the data if they are combined. To this end, we propose Macroeconomic Random Forests, which adapts the canonical Machine Learning (ML) algorithm to the problem of flexibly modeling evolving parameters in a linear macro equation. The approach exhibits clear forecasting gains over a wide range of alternatives and successfully predicts the drastic 2008 rise in unemployment. The obtained generalized time-varying parameters (GTVPs) are shown to behave differently compared to random walk coefficients by adapting nicely to the problem at hand, whether it is regime-switching behavior or long-run structural change. By dividing the typical ML interpretation burden into looking at each TVP separately, I find that the resulting forecasts are, in fact, quite interpretable. An application to the US Phillips curve reveals it is probably not flattening the way you think.