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What model for the target rate

Bruno Feunou (), Fontaine Jean-Sébastien and Jin Jianjian
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Fontaine Jean-Sébastien: Bank of Canada, Ottawa, Ontario, Canada
Jin Jianjian: British Columbia Investment Management Corporation, Victoria, British Columbia, Canada

Studies in Nonlinear Dynamics & Econometrics, 2021, vol. 25, issue 1, 23

Abstract: The Federal Reserve target rate has a lower bound. Changes to the target rate occur with discrete increments. Using out-of-sample forecasts of the target rate, we evaluate models incorporating these two realistic non-linear features. Incorporating these features mitigates in-sample over-fitting and improves out-of-sample forecast accuracy of the target rate level and volatility. A model with these features performs better relative to the linear models because (i) it produces stronger responses of forecasts to inflation and unemployment and a weaker response to lagged target rate, and because (ii) it yields very different forecast distributions when the target rate is close to the lower bound.

Keywords: financial markets; interest rates (search for similar items in EconPapers)
JEL-codes: E43 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1515/snde-2019-0005

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