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Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious?

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Author Info
Carlos Carmona (University of California, San Diego)
Abstract

Inflation forecasts of the Federal Reserve systematically under-predicted inflation before Volcker and systematically over-predicted it afterward. Furthermore, under quadratic loss, commercial forecasts have information not contained in those forecasts. To investigate the cause, this paper recovers the loss function implied by Federal Reserve's forecasts. It finds that the cost of having inflation above an implicit time-varying target was larger than the cost of having inflation below it for the period since Volcker, and that the opposite was true for the pre-Volcker era. Once these asymmetries are taken into account, the Federal Reserve is found to be rational. (JEL C53, E52)

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Paper provided by Department of Economics, UC San Diego in its series University of California at San Diego, Economics Working Paper Series with number 2005-05.

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Date of creation: 01 Jul 2005
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Handle: RePEc:cdl:ucsdec:2005-05

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Keywords: Inflation Forecasts Asymmetric Loss Federal Reserve

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  1. Elliott, Graham & Timmermann, Allan G, 2007. "Economic Forecasting," CEPR Discussion Papers 6158, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  2. Stanislav Anatolyev, 2006. "Dynamic modeling under linear-exponential loss," Working Papers w0092, Center for Economic and Financial Research (CEFIR). [Downloadable!]
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