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How Useful Are Estimated DSGE Model Forecasts for Central Bankers?

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  • Rochelle M. Edge
  • Refet S. Gurkaynak

Abstract

DSGE models are a prominent tool for forecasting at central banks and the competitive forecasting performance of these models relative to alternatives--including official forecasts--has been documented. When evaluating DSGE models on an absolute basis, however, we find that the benchmark estimated medium scale DSGE model forecasts inflation and GDP growth very poorly, although statistical and judgmental forecasts forecast as poorly. Our finding is the DSGE model analogue of the literature documenting the recent poor performance of macroeconomic forecasts relative to simple naive forecasts since the onset of the Great Moderation. While this finding is broadly consistent with the DSGE model we employ--ie, the model itself implies that under strong monetary policy especially inflation deviations should be unpredictable--a 'wrong' model may also have the same implication. We therefore argue that forecasting ability during the Great Moderation is not a good metric to judge models.

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Bibliographic Info

Article provided by Economic Studies Program, The Brookings Institution in its journal Brookings Papers on Economic Activity.

Volume (Year): 41 (2010)
Issue (Month): 2 (Fall) ()
Pages: 209-259

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Handle: RePEc:bin:bpeajo:v:41:y:2010:i:2010-02:p:209-259

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Keywords: bank; banker; DSGE; forecast; macroeconomic;

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References

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  1. Jeff Fuhrer & Giovanni Olivei & Geoffrey M. B. Tootell, 2009. "Empirical estimates of changing inflation dynamics," Working Papers, Federal Reserve Bank of Boston 09-4, Federal Reserve Bank of Boston.
  2. Refet Gürkaynak & Justin Wolfers, 2005. "Macroeconomic Derivatives: An Initial Analysis of Market-Based Macro Forecasts, Uncertainty, and Risk," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER International Seminar on Macroeconomics 2005, pages 11-50 National Bureau of Economic Research, Inc.
  3. Kirdan Lees & Troy Matheson & Christie Smith, 2007. "Open Economy Dsge-Var Forecasting And Policy Analysis: Head To Head With The Rbnz Published Forecasts," CAMA Working Papers, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University 2007-05, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  4. Andrew Atkeson & Lee E. Ohanian., 2001. "Are Phillips curves useful for forecasting inflation?," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Win, pages 2-11.
  5. Faust, Jon & Wright, Jonathan H., 2009. "Comparing Greenbook and Reduced Form Forecasts Using a Large Realtime Dataset," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 27(4), pages 468-479.
  6. Antonello D'Agostino & Domenico Giannone & Paolo Surico, 2005. "(Un)Predictability and Macroeconomic Stability," Macroeconomics, EconWPA 0510024, EconWPA.
  7. Wieland, Volker & Wolters, Maik H, 2010. "The Diversity of Forecasts from Macroeconomic Models of the U.S. Economy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7870, C.E.P.R. Discussion Papers.
  8. Gurkaynak, Refet S. & Sack, Brian T. & Swanson, Eric P., 2007. "Market-Based Measures of Monetary Policy Expectations," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 25, pages 201-212, April.
  9. Adolfson, Malin & Andersson, Michael K. & Lindé, Jesper & Villani, Mattias & Vredin, Anders, 2005. "Modern Forecasting Models in Action: Improving Macroeconomic Analyses at Central Banks," Working Paper Series, Sveriges Riksbank (Central Bank of Sweden) 188, Sveriges Riksbank (Central Bank of Sweden), revised 01 Jun 2006.
  10. Bharat Trehan, 2009. "Survey measures of expected inflation and the inflation process," Working Paper Series, Federal Reserve Bank of San Francisco 2009-10, Federal Reserve Bank of San Francisco.
  11. repec:cbi:wpaper:14/rt/06 is not listed on IDEAS
  12. Rochelle M. Edge & Michael T. Kiley & Jean-Philippe Laforte, 2009. "A comparison of forecast performance between Federal Reserve staff forecasts, simple reduced-form models, and a DSGE model," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2009-10, Board of Governors of the Federal Reserve System (U.S.).
  13. John P. Judd & Bharat Trehan, 1992. "Money, credit, and M2," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue sep4.
  14. D’Agostino, Antonello & Giannone, Domenico, 2006. "Comparing alternative predictors based on large-panel factor models," Working Paper Series, European Central Bank 0680, European Central Bank.
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