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Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve's Approach

Author

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  • David Reifschneider

    (Board of Governors of the Federal Reserve System)

  • Peter Tulip

    (Reserve Bank of Australia)

Abstract

Since November 2007, the Federal Open Market Committee (FOMC) of the US Federal Reserve has regularly published participants' qualitative assessments of the uncertainty attending their individual forecasts of real activity and inflation, expressed relative to that seen on average in the past. The benchmarks used for these historical comparisons are the average root mean squared forecast errors (RMSEs) made by various private and government forecasters over the past twenty years. This paper documents how these benchmarks are constructed and discusses some of their properties. We draw several conclusions. First, if past performance is a reasonable guide to future accuracy, considerable uncertainty surrounds all macroeconomic projections, including those of FOMC participants. Second, different forecasters have similar accuracy. Third, estimates of uncertainty about future real activity and interest rates are now considerably greater than prior to the financial crisis; in contrast, estimates of inflation accuracy have changed little. Finally, fan charts – constructed as plus-or-minus one RMSE intervals about the median FOMC forecast, under the expectation that future projection errors will be unbiased and symmetrically distributed, and that the intervals cover about 70 percent of possible outcomes – provide a reasonable approximation to future uncertainty, especially when viewed in conjuction with the FOMC's qualitative assessments. That said, an assumption of symmetry about the interest rate outlook is problematic if the expected path of the federal funds rate is expected to remain low.

Suggested Citation

  • David Reifschneider & Peter Tulip, 2017. "Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve's Approach," RBA Research Discussion Papers rdp2017-01, Reserve Bank of Australia.
  • Handle: RePEc:rba:rbardp:rdp2017-01
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    References listed on IDEAS

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    Cited by:

    1. Knüppel, Malte & Schultefrankenfeld, Guido, 2018. "Assessing the uncertainty in central banks' inflation outlooks," Discussion Papers 56/2018, Deutsche Bundesbank.
    2. repec:eee:ecanpo:v:61:y:2019:i:c:p:73-84 is not listed on IDEAS
    3. Yellen, Janet L., 2017. "Inflation, Uncertainty, and Monetary Policy : a speech at the "Prospects for Growth: Reassessing the Fundamentals" 59th Annual Meeting of the National Association for Business Economics, Cle," Speech 971, Board of Governors of the Federal Reserve System (U.S.).

    More about this item

    Keywords

    forecast uncertainty; fan charts; interval estimation;

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - 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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