Can the Fed predict the state of the economy?

Abstract

Recent research has documented that the Federal Reserve produces systematic errors in forecasting inflation, real GDP growth, and the unemployment rate, even though these forecasts are unbiased. We show that these systematic errors reveal that the Fed is "surprised" by real and inflationary cycles. Using a modified Mincer-Zarnowitz regression, we show that the Fed knows the state of the economy for the current quarter, but cannot predict it one quarter ahead. We further show that even allowing for an asymmetric loss function the Fed does not appear to know the state of the economy one quarter ahead.

Systematic errors in growth expectations over the business cycle

“…2 However, with some exceptions (Sinclair et al, 2010;Messina et al, 2014;Loungani et al, 2013), the literature has been silent on whether such systematic forecast errors depend on the state of the business cycle.…”

“…Existing research has documented significant business-cycle effects on systematic forecast errors for the U. S. Using a modified Mincer-Zarnowitz regression, Sinclair et al (2010) find that the Federal Reserve's Greenbook forecasts tend to overestimate the growth rate of real gross domestic product (GDP) during recessions and to underestimate it during expansions. These state-dependent systematic forecast errors offset each other when the analysis does not control for the state of the economy.…”

Eliciting GDP Forecasts from the FOMC’s Minutes Around the Financial Crisis

“…The FOMC's decisions are based in part on the Greenbook forecasts, which are economic forecasts produced by the Fed's staff. Romer and Romer (2008), Sinclair, Joutz, and Stekler (2010), Nunes (2013), and Ericsson, Hood, Joutz, Sinclair, and Stekler (2013) inter alia have extensively analyzed the Greenbook forecasts; and Banternghansa and McCracken (2009) and Sheng (2015) have examined the FOMC participants' own forecasts. Stekler and Symington (2016) propose a creative and insightful innovation on such existing studies of U.S. monetary policy.…”

How Biased Are U.S. Government Forecasts of the Federal Debt?

“…This broader usage of the term "forecast" is also in line with Clements and Hendry (2002b, p. 2): "A forecast is any statement about the future". For some previous analyses of these and other governmental and institutional forecasts, see Corder (2005), Engstrom and Kernell (1999), Frankel (2011), Joutz and Stekler (2000), Nunes (2013), Sinclair, Joutz, and Stekler (2010), Romer and Romer (2008), and Tsuchiya (2013). Finally, many prior studies have compared forecasts whose assumptions differ from each other.…”

“…This re-interpretation leads to a standardized reformulation of the estimated forecast biases in terms of business-cycle turning points, augmented by a few additional adjustments. Thus, this approach draws on Sinclair, Joutz, and Stekler (2010), who analyze the Fed's Greenbook forecasts similarly; and on Hendry (1999), who reinterprets IIS-detected outliers in an economic and institutional framework. See also Dyckman and Stekler (1966) and Stekler (1972Stekler ( , 2003.…”