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Interest rate forecasts: a pathology

  • Charles Goodhart
  • Wen Bin Lim
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    This is the first of three prospective papers examining how well forecasters can predict the future time path of short-term interest rates. Most prior work has been done using US data; in this exercise we use forecasts made for New Zealand (NZ) by the Reserve Bank of New Zealand (RBNZ), and those derived from money market yield curves in the UK. In this first exercise we broadly replicate recent US findings for NZ and UK, to show that such forecasts in NZ and UK have been excellent for the immediate forthcoming quarter, reasonable for the next quarter and useless thereafter. Moreover, when ex post errors are assessed depending on whether interest rates have been upwards, or downwards, trending, they are shown to have been biased and, apparently, inefficient. In the second paper we shall examine whether (NZ and UK) forecasts for inflation exhibit the same syndromes, and whether errors in inflation forecasts can help to explain errors in interest rate forecasts. In the third paper we shall set out an hypothesis to explain those findings, and examine whether the apparent ex post forecast inefficiencies may still be consistent with ex ante forecast efficiency. Even if the forecasts may be ex ante efficient, their negligible ex post forecasting ability suggests that, beyond a six months’ horizon from the forecast date, they would be better replaced by a simple ‘no-change thereafter’ assumption.

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    Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 24431.

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    Length: 46 pages
    Date of creation: May 2008
    Date of revision:
    Handle: RePEc:ehl:lserod:24431
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    1. Adolfson, Malin & Andersson, Michael K. & Lindé, Jesper & Villani, Mattias & Vredin, Anders, 2005. "Modern Forecasting Models in Action: Improving Macroeconomic Analyses at Central Banks," Working Paper Series 188, Sveriges Riksbank (Central Bank of Sweden), revised 01 Jun 2006.
    2. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
    3. Lars E. O. Svensson, 2006. "Social Value of Public Information: Comment: Morris and Shin (2002) Is Actually Pro-Transparency, Not Con," American Economic Review, American Economic Association, vol. 96(1), pages 448-452, March.
    4. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
    5. Glenn D. Rudebusch, 2007. "Monetary policy inertia and recent Fed actions," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue jan26.
    6. Glenn D. Rudebusch, 2005. "Monetary policy inertia: fact or fiction?," Working Paper Series 2005-19, Federal Reserve Bank of San Francisco.
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