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Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious?

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  • Carmona, Carlos Capistran

Abstract

Inflation forecasts of the Federal Reserve systematically under-predicted inflation before Volcker and systematically over-predicted it afterward. Furthermore, under quadratic loss, commercial forecasts have information not contained in those forecasts. To investigate the cause, this paper recovers the loss function implied by Federal Reserve’s forecasts. It finds that the cost of having inflation above an implicit time-varying target was larger than the cost of having inflation below it for the period since Volcker, and that the opposite was true for the pre-Volcker era. Once these asymmetries are taken into account, the Federal Reserve is found to be rational. (JEL C53, E52)

Suggested Citation

  • Carmona, Carlos Capistran, 2005. "Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious?," University of California at San Diego, Economics Working Paper Series qt6v28v0b6, Department of Economics, UC San Diego.
    • Handle: RePEc:cdl:ucsdec:qt6v28v0b6
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    More about this item

    Keywords

    Inflation Forecasts; Asymmetric Loss; Federal Reserve;
    All these keywords.

    JEL classification:

    • 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

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