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Reconsidering the Fed's Inflation Forecasting Advantage

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Abstract

Previous studies show the Fed has a forecast advantage over the private sector for inflation, either because it devotes more resources to forecasting or because it has an informational advantage. We evaluate the Fed's forecast advantage to determine how much of it results from the Fed's knowledge of future monetary policy. We develop two tests -- an instrumental variable encompassing test and a path-dependent encompassing test -- to equalize the Fed's information set with the private sector's. We find that Fed forecasts do not encompass those of the private sector when the latter has knowledge of the future of monetary policy. Further, we find that between 20 and 30 percent of the difference between the Fed's and the private sector's mean squared forecast error can be explained by monetary policy.

Suggested Citation

  • Amy Y. Guisinger & Michael W. McCracken & Michael T. Owyang, 2022. "Reconsidering the Fed's Inflation Forecasting Advantage," Working Papers 2022-001, Federal Reserve Bank of St. Louis, revised 23 Oct 2023.
  • Handle: RePEc:fip:fedlwp:93609
    DOI: 10.20955/wp.2022.001
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    References listed on IDEAS

    as
    1. Fair, Ray C & Shiller, Robert J, 1989. "The Informational Context of Ex Ante Forecasts," The Review of Economics and Statistics, MIT Press, vol. 71(2), pages 325-331, May.
    2. Tom Stark, 2010. "Realistic evaluation of real-time forecasts in the Survey of Professional Forecasters," Research Rap Special Report, Federal Reserve Bank of Philadelphia, issue May.
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    More about this item

    Keywords

    conditional encompassing; eurodollar futures; Fed information;
    All these keywords.

    JEL classification:

    • C36 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Instrumental Variables (IV) Estimation
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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