Linear and threshold forecasts of output and inflation using stock and housing prices

This study examines whether simple measures of Canadian equity and housing price misalignments contain leading information about output growth and inflation. Previous authors have generally found that the information content of asset prices in general, and equity and housing prices in particular, are unreliable in that they do not systematically predict future economic activity or inflation. However, earlier studies relied on simple linear relationships that would fail to pick up the potential nonlinear effects of asset price misalignments. Our results suggest that housing prices are useful for predicting GDP growth, even within a linear context. Meanwhile, both stock and housing prices can improve inflation forecasts, especially when using a threshold specification. These improvements in forecast performance are relative to the information contained in Phillips‐curve type indicators for inflation and IS‐curve type indicators for GDP growth. Copyright © 2008 John Wiley & Sons, Ltd.