Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious?

Carlos Capistrán-Carmona
Authors registered in the RePEc Author Service: Carlos Capistrán ()

No 127, Computing in Economics and Finance 2005 from Society for Computational Economics

Abstract: This paper documents that inflation forecasts of the Federal Reserve systematically under-predicted inflation before Volker's appointment as Chairman and systematically over-predicted it afterward. It also documents that, under quadratic loss, commercial forecasts have information not contained in the forecasts of the Federal Reserve. It demonstrates that this evidence leads to a rejection of the joint hypothesis that the Federal Reserve has rational expectations and quadratic loss. To investigate the causes of this failure, this paper uses moment conditions derived from a model of an inflation targeting central bank to back out the loss function implied by the forecasts of the Federal Reserve. It finds that the cost of having inflation above the target was larger than the cost of having inflation below it for the post-Volker Federal Reserve, and that the opposite was true for the pre-Volker era. Once these asymmetries are taken into account, the Federal Reserve is found to be rational and to efficiently incorporate the information contained in forecasts from the Survey of Professional Forecasters

Keywords: Asymmetric loss function; Inflation forecasts; Forecast Evaluation (search for similar items in EconPapers)
JEL-codes: C53 E52 (search for similar items in EconPapers)
Date: 2005-11-11
New Economics Papers: this item is included in nep-cba, nep-ets, nep-for, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Journal Article: Bias in Federal Reserve inflation forecasts: Is the Federal Reserve irrational or just cautious? (2008)
Working Paper: Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious? (2006)
Working Paper: Bias in Federal Reserve Inflation Forecasts: Is the Federal Reserve Irrational or Just Cautious? (2005)
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