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The perils of approximating fixed-horizon inflation forecasts with fixed-event forecasts

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  • James Yetman

Abstract

A common practice in studies using inflation forecasts is to approximate fixed-horizon forecasts with fixed-event ones. Here we show that this may be problematic. In a panel of US inflation forecast data that allows us to compare the two, the approximation results in a mean absolute approximation error of around 0.2-0.3 percentage points (around 10% of the level of inflation), and statistically significant differences in both the variances and persistence of the approximate inflation forecasts relative to the actual forecasts. To reduce these problems, we propose an adjustment to the approximation, consistent with a model where longer-horizon forecasts are more heavily "anchored", while shorter-horizon forecasts more closely reflect current inflation levels.

Suggested Citation

  • James Yetman, 2018. "The perils of approximating fixed-horizon inflation forecasts with fixed-event forecasts," BIS Working Papers 700, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:700
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    References listed on IDEAS

    as
    1. Corbo, Vittorio & Landerretche, Oscar & Schmidt-Hebbel, Klaus, 2001. "Assessing Inflation Targeting after a Decade of World Experience," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(4), pages 343-368, October.
    2. repec:cje:issued:v:50:y:2017:i:3:p:711-737 is not listed on IDEAS
    3. Siklos, Pierre L., 2013. "Sources of disagreement in inflation forecasts: An international empirical investigation," Journal of International Economics, Elsevier, vol. 90(1), pages 218-231.
    4. Aaron Mehrotra & James Yetman, 2018. "Decaying Expectations: What Inflation Forecasts Tell Us about the Anchoring of Inflation Expectations," International Journal of Central Banking, International Journal of Central Banking, vol. 14(5), pages 55-101, December.
    5. Kortelainen, Mika & Paloviita, Maritta & Viren, Matti, 2011. "Observed inflation forecasts and the new Keynesian macro model," Economics Letters, Elsevier, vol. 112(1), pages 88-90, July.
    6. Sophocles Mavroeidis & Mikkel Plagborg-Møller & James H. Stock, 2014. "Empirical Evidence on Inflation Expectations in the New Keynesian Phillips Curve," Journal of Economic Literature, American Economic Association, vol. 52(1), pages 124-188, March.
    7. Kirdan Lees, 2016. "Assessing forecast performance," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 79, pages 1-19., June.
    8. Davies, Anthony & Lahiri, Kajal, 1995. "A new framework for analyzing survey forecasts using three-dimensional panel data," Journal of Econometrics, Elsevier, vol. 68(1), pages 205-227, July.
    9. Jonas Dovern & Ulrich Fritsche, 2008. "Estimating Fundamental Cross-Section Dispersion from Fixed Event Forecasts," Discussion Papers of DIW Berlin 787, DIW Berlin, German Institute for Economic Research.
    10. Johnson, David R., 2002. "The effect of inflation targeting on the behavior of expected inflation: evidence from an 11 country panel," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1521-1538, November.
    11. Ricardo Sousa & James Yetman, 2016. "Inflation expectations and monetary policy," BIS Papers chapters,in: Bank for International Settlements (ed.), Inflation mechanisms, expectations and monetary policy, volume 89, pages 41-67 Bank for International Settlements.
    12. James Yetman, 2017. "The evolution of inflation expectations in Canada and the US," Canadian Journal of Economics, Canadian Economics Association, vol. 50(3), pages 711-737, August.
    13. Stefan Gerlach, 2007. "Interest Rate Setting by the ECB, 1999-2006: Words and Deeds," International Journal of Central Banking, International Journal of Central Banking, vol. 3(3), pages 1-46, September.
    14. Marcel Peter & Scott Roger & Geoffrey M Heenan, 2006. "Implementing Inflation Targeting; Institutional Arrangements, Target Design, and Communications," IMF Working Papers 06/278, International Monetary Fund.
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    More about this item

    Keywords

    fixed-event forecasts; fixed-horizon forecasts; inflation expectations;

    JEL classification:

    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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