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Monetary policy in real time

Domenico Giannone (), Lucrezia Reichlin () and Luca Sala ()

ULB Institutional Repository from ULB -- Universite Libre de Bruxelles

Abstract: We analyze the panel of the Greenbook forecasts (sample 1970-1996) and a large panel of monthly variables for the United States (sample 1970-2003) and show that the bulk of dynamics of both the variables and their forecasts is explained by two shocks. A two-factor model that exploits, in real time, information on many time series to extract a two-dimensional signal produces a degree of forecasting accuracy of the federal funds rate similar to that of the markets and, for output and inflation, similar to that of the Greenbook forecasts. This leads us to conclude that the stochastic dimension of the U.S. economy is two. We also show that dimension two is generated by a real and nominal shock, with output mainly driven by the real shock, and inflation mainly driven by the nominal shock. The implication is that, by tracking any forecastable measure of real activity and price dynamics, the central bank can track all fundamental dynamics in the economy.

Date: 2005
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Published in: Macroeconomics Annual (2005),p.161-200

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