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How Useful Are Estimated DSGE Model Forecasts for Central Bankers?

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  • Edge, Rochelle M
  • Gürkaynak, Refet S.

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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8158.

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Date of creation: Dec 2010
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Handle: RePEc:cpr:ceprdp:8158

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Keywords: DSGE model forecast; forecast comparison; Great Moderation;

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References

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  1. G�rkaynak, Refet S. & Wolfers, Justin, 2005. "Macroeconomic Derivatives: An Initial Analysis of Market-Based Macro Forecasts, Uncertainty and Risk," Working paper 82, Regulation2point0.
  2. Malin Adolfson & Michael K. Andersson & Jesper Lindé & Mattias Villani & Anders Vredin, 2007. "Modern Forecasting Models in Action: Improving Macroeconomic Analyses at Central Banks," International Journal of Central Banking, International Journal of Central Banking, vol. 3(4), pages 111-144, December.
  3. Wieland, Volker & Wolters, Maik H, 2010. "The Diversity of Forecasts from Macroeconomic Models of the U.S. Economy," CEPR Discussion Papers 7870, C.E.P.R. Discussion Papers.
  4. Kirdan Lees & Troy Matheson & Christie Smith, 2007. "Open economy DSGE-VAR forecasting and policy analysis - head to head with the RBNZ published forecasts," Reserve Bank of New Zealand Discussion Paper Series DP2007/01, Reserve Bank of New Zealand.
  5. Bharat Trehan, 2009. "Survey measures of expected inflation and the inflation process," Working Paper Series 2009-10, Federal Reserve Bank of San Francisco.
  6. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2006. "Market-based measures of monetary policy expectations," Working Paper Series 2006-04, Federal Reserve Bank of San Francisco.
  7. 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 2009-10, Board of Governors of the Federal Reserve System (U.S.).
  8. D'Agostino, Antonello & Giannone, Domenico, 2006. "Comparing Alternative Predictors Based on Large-Panel Factor Models," Research Technical Papers 14/RT/06, Central Bank of Ireland.
  9. Andrew Atkeson & Lee E. Ohanian., 2001. "Are Phillips curves useful for forecasting inflation?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-11.
  10. 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, vol. 27(4), pages 468-479.
  11. D''Agostino, Antonello & Giannone, Domenico & Surico, Paolo, 2007. "(Un)Predictability and Macroeconomic Stability," CEPR Discussion Papers 6594, C.E.P.R. Discussion Papers.
  12. John P. Judd & Bharat Trehan, 1992. "Money, credit, and M2," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue sep4.
  13. Jeff Fuhrer & Giovanni Olivei & Geoffrey M. B. Tootell, 2009. "Empirical estimates of changing inflation dynamics," Working Papers 09-4, Federal Reserve Bank of Boston.
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Citations

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Cited by:
  1. Knüppel, Malte & Schultefrankenfeld, Guido, 2013. "The Empirical (Ir)Relevance of the Interest Rate Assumption for Central Bank Forecasts," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 80042, Verein für Socialpolitik / German Economic Association.
  2. Vasco Cúrdia & Marco Del Negro & Daniel L. Greenwald, 2012. "Rare shocks, great recessions," Staff Reports 585, Federal Reserve Bank of New York.
  3. Wolters, Maik Hendrik, 2012. "Evaluating point and density forecasts of DSGE models," MPRA Paper 36147, University Library of Munich, Germany.
  4. Herbst, Edward & Schorfheide, Frank, 2012. "Evaluating DSGE model forecasts of comovements," Journal of Econometrics, Elsevier, vol. 171(2), pages 152-166.
  5. James M. Nason & Gregor W. Smith, 2013. "Reverse Kalman filtering U.S. inflation with sticky professional forecasts," Working Papers 13-34, Federal Reserve Bank of Philadelphia.
  6. Marco Del Negro & Frank Schorfheide, 2012. "DSGE model-based forecasting," Staff Reports 554, Federal Reserve Bank of New York.
  7. Ippei Fujiwara & Yasuo Hirose, 2011. "Indeterminacy and forecastability," Globalization and Monetary Policy Institute Working Paper 91, Federal Reserve Bank of Dallas.
  8. Jon D. Samuels & Rodrigo Sekkel, 2013. "Forecasting with Many Models: Model Confidence Sets and Forecast Combination," Working Papers 13-11, Bank of Canada.
  9. James M. Nason & Gregor W. Smith, 2014. "Measuring the Slowly Evolving Trend in US Inflation with Professional Forecasts," CAMA Working Papers 2014-07, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  10. Bårdsen, Gunnar & den Reijer, Ard & Jonasson, Patrik & Nymoen, Ragnar, 2012. "MOSES: Model for studying the economy of Sweden," Economic Modelling, Elsevier, vol. 29(6), pages 2566-2582.
  11. Arai, Natsuki, 2014. "Using forecast evaluation to improve the accuracy of the Greenbook forecast," International Journal of Forecasting, Elsevier, vol. 30(1), pages 12-19.
  12. Marco Del Negro & Marc Giannoni & Christina Patterson, 2012. "The forward guidance puzzle," Staff Reports 574, Federal Reserve Bank of New York.

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