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Improving Federal-Funds Rate Forecasts in VAR Models Used for Policy Analysis

  • Robertson, John C
  • Tallman, Ellis W

Federal-funds rate-forecast errors from vector autoregressive (VAR) models used for monetary policy analysis and fitted by ordinary least squares (OLS) are large relative to those from the futures market. Using three different structural VAR models, we show that forecasts based on a shrinkage estimator dominate the OLS-based forecasts--even after restricting the lag length and/or imposing exact unit-root restrictions--and are broadly comparable to the futures-market forecasts. Our results refute the perception that VAR models forecast the funds rate poorly in general and suggest that using stochastic prior restrictions can provide an effective way of improving forecast accuracy without sacrificing structural interpretation.

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Article provided by American Statistical Association in its journal Journal of Business and Economic Statistics.

Volume (Year): 19 (2001)
Issue (Month): 3 (July)
Pages: 324-30

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Handle: RePEc:bes:jnlbes:v:19:y:2001:i:3:p:324-30
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  1. Dreze, Jacques H. & Richard, Jean-Francois, 1983. "Bayesian analysis of simultaneous equation systems," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 1, chapter 9, pages 517-598 Elsevier.
  2. Kadiyala, K Rao & Karlsson, Sune, 1997. "Numerical Methods for Estimation and Inference in Bayesian VAR-Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 12(2), pages 99-132, March-Apr.
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  4. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc.
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  6. Thomas Doan & Robert B. Litterman & Christopher A. Sims, 1983. "Forecasting and Conditional Projection Using Realistic Prior Distributions," NBER Working Papers 1202, National Bureau of Economic Research, Inc.
  7. Daniel F. Waggoner & Tao Zha, 1998. "Conditional forecasts in dynamic multivariate models," Working Paper 98-22, Federal Reserve Bank of Atlanta.
  8. Rudebusch, G.D., 1996. "Do Measures of Monetary Policy in a VAR Make Sense?," Papers 269, Banca Italia - Servizio di Studi.
  9. Christopher A. Sims, 1989. "A nine variable probabilistic macroeconomic forecasting model," Discussion Paper / Institute for Empirical Macroeconomics 14, Federal Reserve Bank of Minneapolis.
  10. Christopher A. Sims & Tao Zha, 1996. "Bayesian methods for dynamic multivariate models," Working Paper 96-13, Federal Reserve Bank of Atlanta.
  11. Fair, Ray C & Shiller, Robert J, 1990. "Comparing Information in Forecasts from Econometric Models," American Economic Review, American Economic Association, vol. 80(3), pages 375-89, June.
  12. Tao Zha, 1998. "A dynamic multivariate model for use in formulating policy," Economic Review, Federal Reserve Bank of Atlanta, issue Q 1, pages 16-29.
  13. Charles L. Evans & Kenneth N. Kuttner, 1998. "Can VAR's describe monetary policy?," Working Paper Series WP-98-19, Federal Reserve Bank of Chicago.
  14. Wallis, Kenneth F, 1989. "Macroeconomic Forecasting: A Survey," Economic Journal, Royal Economic Society, vol. 99(394), pages 28-61, March.
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  16. John C. Robertson & Ellis W. Tallman, 1999. "Vector autoregressions: forecasting and reality," Economic Review, Federal Reserve Bank of Atlanta, issue Q1, pages 4-18.
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