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Do Fed Forecast Errors Matter?

Author

Listed:
  • Pao-Lin Tien

    (Bureau of Economic Analysis)

  • Tara M. Sinclair

    (The George Washington University)

  • Edward N. Gamber

    (Congressional Budget Office)

Abstract
There is a large literature evaluating the forecasts of the Federal Reserve by testing their rationality and measuring the size of their forecast errors. There is also a substantial literature and debate on the impact of the Fed’s monetary policy on the economy. We know little, however about the impact of the Fed’s 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, we treat the Fed’s forecast errors as a shock, analogous to a monetary policy shock. Our shock, however, is different in that it is completely unintended by the monetary authority rather than simply unanticipated by the public. 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 absolute magnitude of the forecast error shock is large, the impact of the shock on the macroeconomy is quite small. This finding is robust across a range of different specifications. The maximum impact suggests a decline of less than 0.3 percent of real GDP and less than 0.4 percent of GDP deflator in response to a 100 basis point contractionary forecast error shock.

Suggested Citation

  • Pao-Lin Tien & Tara M. Sinclair & Edward N. Gamber, 2016. "Do Fed Forecast Errors Matter?," Working Papers 2016-007, The George Washington University, Department of Economics, H. O. Stekler Research Program on Forecasting.
    • Handle: RePEc:gwc:wpaper:2016-007
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    4. Pierre L. Siklos, 2017. "What has publishing inflation forecasts accomplished? Central banks and their competitors," CAMA Working Papers 2017-33, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
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    7. Jennifer L. Castle & David F. Hendry & Andrew B. Martinez, 2017. "Evaluating Forecasts, Narratives and Policy Using a Test of Invariance," Econometrics, MDPI, vol. 5(3), pages 1-27, September.
    8. 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.

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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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