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Monetary policy in real time

Author

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  • Domenico Giannone
  • Lucrezia Reichlin
  • Luca Sala

Abstract

We analyze the panel of the Greenbook forecasts (sample 1970-1996) and a large panel of monthly variables for the United States (sample 1970-2003) and show that the bulk of dynamics of both the variables and their forecasts is explained by two shocks. A two-factor model that exploits, in real time, information on many time series to extract a two-dimensional signal produces a degree of forecasting accuracy of the federal funds rate similar to that of the markets and, for output and inflation, similar to that of the Greenbook forecasts. This leads us to conclude that the stochastic dimension of the U.S. economy is two. We also show that dimension two is generated by a real and nominal shock, with output mainly driven by the real shock, and inflation mainly driven by the nominal shock. The implication is that, by tracking any forecastable measure of real activity and price dynamics, the central bank can track all fundamental dynamics in the economy.

Suggested Citation

  • Domenico Giannone & Lucrezia Reichlin & Luca Sala, 2005. "Monetary policy in real time," ULB Institutional Repository 2013/6401, ULB -- Universite Libre de Bruxelles.
  • Handle: RePEc:ulb:ulbeco:2013/6401
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    More about this item

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • 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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