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Do Fed Forecast Errors Matter?

Author

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  • Pao-Lin Tien

    (Department of Economics, Wesleyan University)

  • Tara M. Sinclair

    (The George Washington University)

  • Edward N. Gamber

    (Congressional Budget Office)

Abstract

There is a large literature evaluating forecasts by testing the rationality of forecasts and measuring the size of forecast errors, but we know little about the impact of forecast errors on economic outcomes. This paper constructs a measure of a forecast error shock for the Federal Reserve based on the assumption that the Fed follows a forward-looking Taylor rule. Given the effort the Fed puts towards producing forecasts that do not have an endogenous error component, this forecast error shock should be comparable to traditional monetary policy shocks and thus can be used to measure the impact of the Fed’s forecast errors on the U.S. economy. We follow Romer and Romer (2004) and investigate the effect of the forecast error shock on output and price movements. Our results suggest that although the magnitude of the forecast error shock is large, the impact of our shock on the macroeconomy is quite small. The impact is somewhat larger when we take into consideration the Fed’s inability to forecast recessions. The maximum impact across all potential models suggests a decline of approximately one percent of real GDP and two percent of GDP deflator in response to a one standard deviation contractionary forecast error shock.

Suggested Citation

  • Pao-Lin Tien & Tara M. Sinclair & Edward N. Gamber, 2015. "Do Fed Forecast Errors Matter?," Wesleyan Economics Working Papers 2015-004, Wesleyan University, Department of Economics.
  • Handle: RePEc:wes:weswpa:2015-004
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    Cited by:

    1. Ettmeier, Stephanie & Kriwoluzky, Alexander, 2019. "Same, but different? Testing monetary policy shock measures," Economics Letters, Elsevier, vol. 184(C).
    2. Jennifer L. Castle & David F. Hendry & Andrew B. Martinez, 2017. "Evaluating Forecasts, Narratives and Policy Using a Test of Invariance," Econometrics, MDPI, Open Access Journal, vol. 5(3), pages 1-27, September.
    3. Siklos, Pierre, 2017. "What Has Publishing Inflation Forecasts Accomplished? Central Banks And Their Competitors," LCERPA Working Papers 0098, Laurier Centre for Economic Research and Policy Analysis, revised 01 Apr 2017.
    4. Michael T. Belongia & Peter N. Ireland, 2018. "Monetary Policy Lessons from the Greenbook," Boston College Working Papers in Economics 955, Boston College Department of Economics.
    5. Jennifer Castle & David Hendry, 2016. "Policy Analysis, Forediction, and Forecast Failure," Economics Series Working Papers 809, University of Oxford, Department of Economics.

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    More about this item

    Keywords

    Federal Reserve; Taylor rule; forecast evaluation; monetary policy shocks;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • 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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