Do Fed Forecast Errors Matter?

37 Pages Posted: 27 Jul 2016

See all articles by Pao-Lin Tien

Pao-Lin Tien

Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; Wesleyan University - Department of Economics

Tara M. Sinclair

George Washington University - Department of Economics; George Washington University - Elliott School of International Affairs (ESIA); George Washington University - Institute For International Economic Policy (GWIIEP); George Washington University - Research Program on Forecasting; George Washington University - George Washington Institute of Public Policy (GWIPP); Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA); Halle Institute for Economic Research

Edward Gamber

Congressional Budget Office

Date Written: July 26, 2016

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.

Keywords: Federal Reserve, Taylor rule, forecast evaluation, monetary policy shocks

JEL Classification: E32, E31, E52, E58

Suggested Citation

Tien, Pao-Lin and Sinclair, Tara M. and Gamber, Edward, Do Fed Forecast Errors Matter? (July 26, 2016). CAMA Working Paper No. 47/2016 . Available at SSRN: https://ssrn.com/abstract=2814810 or http://dx.doi.org/10.2139/ssrn.2814810

Pao-Lin Tien

Bureau of Economic Analysis ( email )

1441 L Street NW
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Board of Governors of the Federal Reserve System ( email )

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Wesleyan University - Department of Economics ( email )

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Tara M. Sinclair (Contact Author)

George Washington University - Department of Economics ( email )

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Washington, DC 20052
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202-944-7988 (Phone)
202-994-6147 (Fax)

HOME PAGE: http://home.gwu.edu/~tsinc/

George Washington University - Elliott School of International Affairs (ESIA) ( email )

2201 G Street, N.W.
Washington, DC 20052
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202-994-7988 (Phone)
202-994-6147 (Fax)

HOME PAGE: http://home.gwu.edu/~tsinc/

George Washington University - Institute For International Economic Policy (GWIIEP) ( email )

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United States

George Washington University - Research Program on Forecasting ( email )

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George Washington University - George Washington Institute of Public Policy (GWIPP) ( email )


United States

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA) ( email )

ANU College of Business and Economics
Canberra, Australian Capital Territory 0200
Australia

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

HOME PAGE: http://www.dpe-halle.de/asp/person.asp?xtr&Lang=e

Edward Gamber

Congressional Budget Office ( email )

Ford House Office Building
2nd & D Streets, SW
Washington, DC 20515-6925
United States

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