This paper investigates the change in private-sector and Federal Reserve forecasts before and after the Great Moderation. We view the Great Moderation as a natural experiment. Using forecasts produced by the Survey of Professional Forecasters and the Federal Reserve (Greenbook forecasts) we investigate four questions: 1) How large was the decline in forecast errors? 2) Did forecast accuracy improve relative to the decline in volatility of growth and inflation? 3) Did forecasters respond to the Great Moderation? 4) What are the potential benefits to monetary policymakers of smaller forecast errors? We find that the absolute median error as well as the cross-sectional volatility of forecast errors decreased significantly. Forecasters appeared to have narrowed the dispersion of their forecasts in response to the Great Moderation. Forecast accuracy did not improve relative to the reduction in the volatility of the economy. To the extent that the Fed is forward-looking when it sets its federal funds rate target, improvements in forecast accuracy imply substantial improvements in the Fed’s ability to reach its optimum federal funds rate target.
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Paper provided by The George Washinton University, Department of Economics, Research Program on Forecasting in its series Working Papers with number
2008-001.
Find related papers by JEL classification: E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation