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Thursday, February 23, 2012

Strategic Forecasting at the Fed

Minimizing the forecast error, i.e. providing the best possible forecast of future variables such as output, inflation and employment, does not appear to be the main goal of some members of the Fed's monetary policy committee. Instead, the forecasts appear to be set strategically in an attempt to influence policy decisions:

Federal Open Market Committee forecasts: Guesses or guidance?, by Peter Tillmann, Vox EU: On 25 January 2012, the Federal Open Market Committee (FOMC), the decision-making body of the US Federal Reserve, took yet another step towards higher transparency of US monetary policy. Besides publishing the usual set of macroeconomic forecasts, the FOMC for the first time also published the interest-rate projections formulated by its members...
A week later ... Richard W Fisher, president of the Federal Reserve Bank of Dallas ... argued that “at best, the economic forecasts and interest-rate projections of the FOMC are ultimately pure guesses”. Furthermore, he said that “forecasts issued by the FOMC are tactical judgments of the moment, made within a broader strategic context”...
Given the enormous attention Fed watchers pay to every piece of information officially endorsed by the Fed, the interpretation of the economic projections is a highly topical question. If projections were just “guesses”, the ability to guide market expectations would eventually suffer.
FOMC vs private-sector forecasts ...Gavin and Mandal (2003) ... show that the FOMC’s real growth forecasts are at least as good as those provided by the private sector. The inflation forecasts were more accurate than private-sector forecasts. In light of these findings, Fisher’s (2012) first conjecture seems less convincing.
But what about Fisher’s (2012) other claim..., are motives other than achieving maximum forecast accuracy reflected in FOMC projections? One interpretation is that members pursue strategic motives to have an additional leverage on policy decisions of the committee. ... McCracken (2010) argues that “... an inflation hawk has an incentive to forecast very high inflation regardless of whether that outcome is the most likely, and an inflation dove has a similar set of incentives to forecast lower inflation.”
Strategic forecasting: Voting vs non-voting members’ forecasts ...While all regional presidents take an active part in the policy deliberation, the formal voting right rotates across Federal Reserve districts. ... While only a subgroup of members votes on interest-rate policy, all FOMC members regularly submit forecasts for important macroeconomic variables. The incentives to pursue strategic motives are stronger for members without a direct say on policy. ...
I show that non-voters systematically over-predict inflation relative to the consensus forecast if they favor tighter policy and under-predict inflation if they prefer looser policy. These findings are consistent with non-voting members following strategic motives in forecasting ... to influence policy.
This line of research is extended in my research with Jan-Christoph Rülke... We test whether these forecasts exhibit herding behavior, a pattern often found in private-sector forecasts. While growth and unemployment forecasts do not show herding behavior, the inflation forecasts exhibit strong evidence of anti-herding, i.e. FOMC members intentionally scatter their forecasts around the consensus. Interestingly, anti-herding is more important for non-voting members than for voters. Put differently, non-voting members submit forecasts that are systematically further away from the forecast consensus. ...
Are FOMC forecasts special? Taken together, there is indeed evidence suggesting that motives other than forecast accuracy play a role in the forecasting process. Is this a case for concern? Probably not. It ... is well known that professional forecasts are affected by factors other than accuracy (see Lamont 2002 and Pons-Novell 2003). The available empirical evidence suggests that FOMC members are prone to similar incentives. While individual forecasts might be affected by those factors, the distribution of views among committee members can still be a valuable source of information...

    Posted by on Thursday, February 23, 2012 at 12:20 AM in Economics, Monetary Policy | Permalink  Comments (2)


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