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News versus Surprise in Structural Forecasting Models: Central Bankers' Practical Perspective

Author

Listed:
  • Karel Musil
  • Stanislav Tvrz
  • Jan Vlcek

Abstract

The paper deals with the treatment of shocks in central banks' forecasts. Within the rational expectations (RE) concept, which is widely used in structural macroeconomic models, the paper highlights the differences between news and surprise shocks and argues that most shocks in central bank forecasts should be treated as news. The paper also points out some drawbacks of news shocks under the assumption of full information from the practical point of view of forecasting and policy decision-making at central banks. As a potential solution, the paper refers to the LIRE concept as introduced in Brazdik et al. (2020). The paper discusses the properties of the LIRE concept and finds it versatile and useful in dealing with news shocks without abandoning the RE framework. The paper concludes that LIRE can be effectively used for practical structural macroeconomic modelling.

Suggested Citation

  • Karel Musil & Stanislav Tvrz & Jan Vlcek, 2021. "News versus Surprise in Structural Forecasting Models: Central Bankers' Practical Perspective," Research and Policy Notes 2021/02, Czech National Bank.
    • Handle: RePEc:cnb:rpnrpn:2021/02
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    References listed on IDEAS

    as
    1. Stephanie Schmitt‐Grohé & Martín Uribe, 2012. "What's News in Business Cycles," Econometrica, Econometric Society, vol. 80(6), pages 2733-2764, November.
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    3. Woodford, Michael & Xie, Yinxi, 2022. "Fiscal and monetary stabilization policy at the zero lower bound: Consequences of limited foresight," Journal of Monetary Economics, Elsevier, vol. 125(C), pages 18-35.
    4. Arturo Estrella & Jeffrey C. Fuhrer, 2002. "Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational-Expectations Models," American Economic Review, American Economic Association, vol. 92(4), pages 1013-1028, September.
    5. Takeshi Yagihashi, 2020. "DSGE Models Used by Policymakers: A Survey," Discussion papers ron333, Policy Research Institute, Ministry of Finance Japan.
    6. Jeremy Rudd & Karl Whelan, 2007. "Modeling Inflation Dynamics: A Critical Review of Recent Research," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 155-170, February.
    7. Gelain, Paolo & Iskrev, Nikolay & J. Lansing, Kevin & Mendicino, Caterina, 2019. "Inflation dynamics and adaptive expectations in an estimated DSGE model," Journal of Macroeconomics, Elsevier, vol. 59(C), pages 258-277.
    8. de Groot, Oliver & Mazelis, Falk, 2020. "Mitigating the forward guidance puzzle: inattention, credibility, finite planning horizons and learning," Working Paper Series 2426, European Central Bank.
    9. Michael Woodford, 2019. "Monetary Policy Analysis When Planning Horizons Are Finite," NBER Macroeconomics Annual, University of Chicago Press, vol. 33(1), pages 1-50.
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    13. Jeffrey C. Fuhrer, 2012. "Real expectations: replacing rational expectations with survey expectations in dynamic macro models," Working Papers 12-19, Federal Reserve Bank of Boston.
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    More about this item

    Keywords

    Anticipated shocks; conditional forecast; DSGE models; rational expectations;
    All these keywords.

    JEL classification:

    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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