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Do Fed Forecast Errors Matter?

Pao-Lin Tien (), Tara Sinclair and Edward N. Gamber ()
Additional contact information
Edward N. Gamber: Congressional Budget Office

No 2016-007, Working Papers from The George Washington University, Department of Economics, H. O. Stekler Research Program on Forecasting

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 (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 E58 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2016-09
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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https://www2.gwu.edu/~forcpgm/2016-007.pdf First version, 2016 (application/pdf)

Related works:
Journal Article: Do Fed Forecast Errors Matter? (2021) Downloads
Working Paper: Do Fed Forecast Errors Matter? (2018) Downloads
Working Paper: Do Fed forecast errors matter? (2016) Downloads
Working Paper: Do Fed Forecast Errors Matter? (2015) Downloads
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