Do Fed Forecast Errors Matter?*

Abstract

In order to make forward‐looking policy decisions, the Fed relies on imperfect forecasts of future macroeconomic conditions. If the Fed’s forecasts are rational, then the difference between the actual outcome and the Fed’s forecast is exogenous to the information set of the Fed at the time the forecast was produced. We investigate the effect of the Fed’s forecast errors on output and price movements under the assumption that the Fed intends to implement policy through a forward‐looking Taylor rule with perfect foresight. Our results suggest that although the mean absolute magnitude of the Fed’s forecast errors is large, the impact on the macroeconomy is reassuringly small, although the impact is larger when we take into consideration the Fed’s inability to forecast recessions.

Central bank forecasting: A survey

“…For current quarter Greenbook forecasts of inflation, growth, and unemployment, the coefficients on the regression dummies are not statistically significant, but for next-quarter forecasts they are statistically significant, implying that the Fed either lacked information on the state of the economy in the next quarter, or failed to incorporate this information into their forecasts. Tien et al (2021) find that Greenbook inflation and growth forecasts are unbiased even though errors are sometimes large. van Norden (2018, 2019) find mixed evidence of bias but little evidence of inefficiency when considering Greenbook forecasts of fiscal variables.…”

“…Tien et al. (2021) find that Greenbook inflation and growth forecasts are unbiased even though errors are sometimes large. Croushore and van Norden (2018, 2019) find mixed evidence of bias but little evidence of inefficiency when considering Greenbook forecasts of fiscal variables.…”

An evaluation of the inflation forecasting performance of the European Central Bank, the Federal Reserve, and the Bank of England

“…A more recent study by El-Shagi et al (2016) showed that the forecasting performance of the Fed staff is not stable in the presence of large macroeconomic shocks. Tien et al (2021) concluded that Fed's inflation forecasts are unbiased despite large errors.…”