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Rational vs. professional forecasts

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  • João Valle e Azevedo

Abstract

We compare theoretical and empirical forecasts computed by rational agents living in a model economy to those produced by professional forecasters. We focus on the variance of the prediction errors as a function of the forecast horizon and analyze the speed with which it converges to a constant (which can be seen as a measure of the speed of convergence of the economy to the steady state). We look at a standard sticky-prices-wages model, concluding that it delivers a strong theoretical forecastability of the variables under scrutiny, at odds with the data (professional forecasts). The flexible prices-wages version delivers a forecastability closer to the data and performs relatively better empirically (with actual data), but mainly because forecasts deviate little from the unconditional mean. These results can be interpreted in at least two ways: first, actual deviations from the steady-state are not persistent, in which case the implications of the specific formulation of nominal rigidities for short-run dynamics are unrealistic; second, and still looking through the lens of a model, exogenous (or unmodelled) steady-state shifts attributable to, e.g., changes in monetary-policy, taxation, regulation or in the growth of the technological frontier, occur in such a way as to strongly limit the performance of professional forecasters.
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  • João Valle e Azevedo, 2011. "Rational vs. professional forecasts," Economic Bulletin and Financial Stability Report Articles and Banco de Portugal Economic Studies, Banco de Portugal, Economics and Research Department.
  • Handle: RePEc:ptu:bdpart:b201108
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    More about this item

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications

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