Heather D. Gibson

Bank of Greece


Stephen G. Hall

University of Leicester, Bank of Greece and University of Pretoria


George S. Tavlas

Bank of Greece and Hoover Institution, Stanford University




We provide a new way of deriving a number of dynamic unobserved factors from a set of variables. We show how standard principal components may be expressed in state space form and estimated using the Kalman filter. To illustrate our procedure we perform two exercises. First, we use it to estimate a measure of the current-account imbalances among northern and southern euro-area countries that developed during the period leading up to the outbreak of the euro-area crisis, before looking at adjustment in the post-crisis period. Second, we show how these dynamic factors can improve forecasting of the euro-dollar exchange rate.


Keywords: Principal Components, Factor Models, Underlying activity, Forecasts

JEL Classification: E3, G01, G14, G21


Acknowledgements: We are very grateful to Apostolis Serletis, the Associate Editor, and two referees for constructive comments on an earlier draft. The views expressed in this paper are the authors’ own and do not necessarily represent those of the institutions with which they are affiliated.

George Tavlas
Alternate to the Governor of the Bank of Greece on the ECB Governing Council and Distinguished Visiting Fellow at the Hoover Institution, Stanford University
Bank of Greece
21 E Venizelos Ave
Athens, 10250, Greece
Tel. no. +30 210 320 2370
Fax. no. +30 210 320 2432
Email address: gtavlas@bankofgreece.gr


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