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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. Rudebusch, G.D., 1996. "Do Measures of Monetary Policy in a VAR Make Sense?," Papers 269, Banca Italia - Servizio di Studi.
  2. Daniel F. Waggoner & Tao Zha, 1999. "Conditional Forecasts In Dynamic Multivariate Models," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 639-651, November.
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  6. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  7. Christopher A. Sims & Tao Zha, 1996. "Bayesian methods for dynamic multivariate models," FRB Atlanta Working Paper 96-13, Federal Reserve Bank of Atlanta.
  8. Christopher A. Sims, 1989. "A nine variable probabilistic macroeconomic forecasting model," Discussion Paper / Institute for Empirical Macroeconomics 14, Federal Reserve Bank of Minneapolis.
  9. Kadiyala, K. Rao & Karlsson, Sune, 1994. "Numerical Aspects of Bayesian VAR-modeling," SSE/EFI Working Paper Series in Economics and Finance 12, Stockholm School of Economics.
  10. Wallis, Kenneth F, 1989. "Macroeconomic Forecasting: A Survey," Economic Journal, Royal Economic Society, vol. 99(394), pages 28-61, March.
  11. Thomas Doan & Robert B. Litterman & Christopher A. Sims, 1986. "Forecasting and conditional projection using realistic prior distribution," Staff Report 93, Federal Reserve Bank of Minneapolis.
  12. Charles Evans & Kenneth Kuttner, 1998. "Can VARs describe monetary policy?," Research Paper 9812, Federal Reserve Bank of New York.
  13. Francis X. Diebold & Robert S. Mariano, 1994. "Comparing Predictive Accuracy," NBER Technical Working Papers 0169, National Bureau of Economic Research, Inc.
  14. 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.
  15. John C. Robertson & Ellis W. Tallman, 1999. "Vector autoregressions: forecasting and reality," Economic Review, Federal Reserve Bank of Atlanta, issue Q1, pages 4-18.
  16. John C. Robertson & Ellis W. Tallman, 1998. "Data vintages and measuring forecast model performance," Economic Review, Federal Reserve Bank of Atlanta, issue Q 4, pages 4-20.
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