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Using forecasts to uncover the loss function of FOMC members

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Author Info

  • Christian Pierdzioch

    ()
    (University of Hamburg)

  • Jan-Christoph Rülke

    ()
    (University of Vallendar)

  • Peter Tillmann

    ()
    (University of Giessen)

Abstract

We revisit the sources of the bias in Federal Reserve forecasts and assess whether a precautionary motive can explain the forecast bias. In contrast to the existing literature, we use forecasts submitted by individual FOMC members to uncover members' implicit loss function. Our key finding is that the loss function of FOMC members is asymmetric: FOMC members incur a higher loss when they underpredict (overpredict) inflation and unemployment (real GDP) as compared to an overprediction (underprediction) of similar size. Our findings add to the recent controversy on the relative quality of FOMC forecasts compared to staff forecasts. Together with Capistran's (2008) finding of similar asymmetries in Federal Reserve staff forecasts our results suggest that differences in predictive ability do not stem from differences in preferences. This is underlined by our second result: forecasts remain biased even after accepting an asymmetric loss function.

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Bibliographic Info

Paper provided by Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung) in its series MAGKS Papers on Economics with number 201302.

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Length: 33 pages
Date of creation: 2013
Date of revision:
Publication status: Forthcoming in
Handle: RePEc:mar:magkse:201302

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Keywords: Federal Open Market Committee; forecasting; asymmetric loss function; monetary policy;

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References

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  1. Carlos Capistrán-Carmona, 2005. "Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious?," Computing in Economics and Finance 2005 127, Society for Computational Economics.
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  23. Pierdzioch, Christian & Rülke, Jan-Christoph & Stadtmann, Georg, 2012. "On the loss function of the Bank of Canada: A note," Economics Letters, Elsevier, vol. 115(2), pages 155-159.
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Cited by:
  1. El-Shagi, Makram & Jung, Alexander, 2013. "Does the Greenspan era provide evidence on leadership in the FOMC?," Working Paper Series 1579, European Central Bank.

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