Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve's Approach

48 Pages Posted: 1 Mar 2017

See all articles by David Reifschneider

David Reifschneider

Federal Reserve Board - Division of Research and Statistics

Peter Tulip

Reserve Bank of Australia

Date Written: 2017-02-24

Abstract

Since November 2007, the Federal Open Market Committee (FOMC) of the U.S. Federal Reserve has regularly published participants’ qualitative assessments of the uncertainty attending their individual forecasts of real activity and inflation, expressed relative to that seen on average in the past. The benchmarks used for these historical comparisons are the average root mean squared forecast errors (RMSEs) made by various private and government forecasters over the past twenty years. This paper documents how these benchmarks are constructed and discusses some of their properties. We draw several conclusions. First, if past performance is a reasonable guide to future accuracy, considerable uncertainty surrounds all macroeconomic projections, including those of FOMC participants. Second, different forecasters have similar accuracy. Third, estimates of uncertainty about future real activity and interest rates are now considerably greater than prior to the financial crisis; in contrast, estimates of inflation accuracy have changed little. Finally, fan charts-constructed as plus-or-minus one RMSE intervals about the median FOMC forecast, under the expectation that future projection errors will be unbiased and symmetrically distributed, and that the intervals cover about 70 percent of possible outcomes-provide a reasonable approximation to future uncertainty, especially when viewed in conjunction with the FOMC's qualitative assessments. That said, an assumption of symmetry about the interest rate outlook is problematic if the expected path of the federal funds rate is expected to remain low.

Keywords: FOMC, Fan Charts, Forecasting, Uncertainty

JEL Classification: E58, E37, C53

Suggested Citation

Reifschneider, David and Tulip, Peter, Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve's Approach (2017-02-24). FEDS Working Paper No. 2017-020. Available at SSRN: https://ssrn.com/abstract=2925704 or http://dx.doi.org/10.17016/FEDS.2017.020

David Reifschneider (Contact Author)

Federal Reserve Board - Division of Research and Statistics ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2941 (Phone)

Peter Tulip

Reserve Bank of Australia ( email )

GPO Box 3947
Sydney, NSW 2001
Australia
61-2-9551-8831 (Phone)

HOME PAGE: http://www.petertulip.com

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