Forecasting and Policy Making (Paper) - Center for Financial Studies

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slightly below the forecasts from the non-structural models. Figure 8 displays projections for quarter-to-quarter CPI inflation and for the federal funds rate. The model correctly predicts inflation to fall during the recession, but it fails to capture the 5 0 −5 −10 Quarterly annualized inflation rate 2007 2008 2009 2010 2011 6 4 2 0 −2 Nominal short term interest rate 2007 2008 2009 2010 2011 Figure 8: Data (black line) and forecasts (blue lines) of annualized quarter-on-quarter inflation and the federal funds rate. extreme decline in the fourth quarter of 2008. ¿From 2009 onwards inflation projections are fairly precise. The projections of the federal funds rate explain why output growth estimates during the recovery turn out too optimistic. The model forecast does not enforce the zero bound on nominal interest rates. It allows rates to turn negative thereby incorporating too much stimulus to output. Imposing the zero-interest-floor on nominal interest rates would have resulted in less optimistic output forecasts. We will demonstrate a simple procedure for adjusting forecasts to take into account the zero-lower-bound in section 5.6. Structural shocks and forecast interpretation Another unobservable element of structural models are the economic shocks. Structural shocks differ from estimation residuals. They require identification via parametric restrictions and in models with forward-looking terms the computation of the rational expectation of future variables so as to determine the forecast error. As a result of the identification the shock can possibly be interpreted as a meaningful economic disturbance. Of course, the extent of useful interpretation depends on the economic foundations for the parametric restrictions in the model. Since the IMF projection model is not strictly micro-founded in all respects, some of these shocks have little concrete interpretation such as the shocks to potential output growth. But other shocks offer useful insights. For example, distinguishing aggregate demand shocks in the IS curve, from cost-push shocks in the Phillips curve and long-run supply shocks to potential output, helps understanding whether inflation is primarily driven by demand-pull factors, short-run cost-push shocks or productivity changes that may be related to technological improvements. Figure 9 display the estimated series of structural shocks. The sequence of negative demand shocks between 2008 and 2010 indicates that according to this model an unexpected shortfall of demand (i.e. the shocks) caused an unexpected decline in GDP. Furthermore, the sequence of positive monetary policy shocks in 2009 indicates that interest rates where higher than expected based on the policy rule, and therefore represented an additional cause for an unexpected decline in GDP. The 44
1 0 −1 −2 2 1 0 −1 4 2 0 −2 −4 Demand Shock 2007 2008 2009 2010 2011 Monetary Policy Shock 2007 2008 2009 2010 2011 Bank Lending Condition Shock 2007 2008 2009 2010 2011 10 5 0 −5 0.2 0 −0.2 0.5 0 −0.5 −1 Cost−Push Shock 2007 2008 2009 2010 2011 Unemployment Shock 2007 2008 2009 2010 2011 Potential Output Growth Shock 2007 2008 2009 2010 2011 Figure 9: Estimated shocks in the IMF’s quarterly projection model. sequence of negative shocks to potential GDP growth and the sequence of positive shocks to bank lending conditions are also causes for an unexpected drop in GDP. In sum, these shocks reflect again the inability of the model to forecast the recession, but they help point to the corner from which the unexpected shortfall originates. The forecasting power of the model arises from predictable endogenous dynamics such as lags of output, inflation or interest rates, and from predictable exogenous dynamics such as the persistence of the bank lending conditions shocks. The sequence of positive monetary policy shocks in 2009 may be due to the omission of the zero bound. Including this constraint may therefore improve the forecasting of GDP somewhat. The large positive cost-push shock in 2008Q4 reflects the failure of forecasting the decline in inflation since this shock enters the Phillips curve negatively. According to this model the drop in inflation is largely due to a sudden decline in costs and to a lesser extent to disinflationary impact of a shortfall of demand. Thus, without using data on energy prices the model indicates that the decline of energy costs was largely behind the drop in inflation in 2008Q4. A sequence of positive shocks to unemployment in 2010 represents a source of unexpectedly high unemployment at the end of the recession according to this model. Finally, one can explore the parameter estimates of the model to gauge the importance of differ- ent channels of influence in determining the forecast. One could also re-estimate the model for each forecast to investigat whether certain parameter values change a lot over time and thus spot structural changes. Here, we only point out the parameters governing the shock process to potential output. The estimates show that each quarter potential output growth equals 0.93 times the previous potential output growth rate plus 0.07 times steady state growth. It thus takes a long time until potential output growth returns back to steady state. On the other hand, the estimation results show that the estimated variance of the growth rate of potential output is relatively high. In Figure 9 the lower right panel 45
Page 1 and 2: Forecasting and Policy Making ∗ V
Page 3 and 4: 1 Introduction Gouverner c’est pr
Page 5 and 6: to return to target within an accep
Page 7 and 8: In contrast to the CBO forecast the
Page 9 and 10: forecast and for the same projectio
Page 11 and 12: national central banks also publish
Page 13 and 14: In practice, central banks have not
Page 15 and 16: Item (v) on Tinbergen’s list requ
Page 17 and 18: ule and can also be expressed as a
Page 19 and 20: prescription within one quarter. Si
Page 21 and 22: By now there are several studies th
Page 23 and 24: of interest-rate-smoothing (ρ > 0.
Page 25 and 26: These findings provide evidence tha
Page 27 and 28: With the funds rate near zero, the
Page 29 and 30: These results suggest that rules wi
Page 31 and 32: clear that all estimates for the eu
Page 33 and 34: use other available information tha
Page 35 and 36: VARs. The advantage of non-structur
Page 37 and 38: The notation of equations, variable
Page 39 and 40: ealizations. This state of the econ
Page 41 and 42: librium real interest rate, ηt a v
Page 43: 2 0 −2 −4 −6 x 104 1.4 1.2 1
Page 47 and 48: less flexible than, for example, mo
Page 49 and 50: 4 2 0 −2 Quarterly annualized inf
Page 51 and 52: Figure 13: The figure shows a histo
Page 53 and 54: at the Fed since 1996. Its characte
Page 55 and 56: Advantages and disadvantages of dif
Page 57 and 58: Adolfson et al. (2007a) and Maih (2
Page 59 and 60: ule, the dashed line the constant i
Page 61 and 62: 8 6 4 2 0 −2 −4 −6 −8 data
Page 63 and 64: 1 −1 1 −1 1 −1 1 −1 1 −1
Page 65 and 66: Figure 17 plots the p-values of the
Page 67 and 68: itself might be the crucial factor
Page 69 and 70: Figure 21 indicates that the recess
Page 71 and 72: Only for the 2008/2009 recession th
Page 73 and 74: We start by determining the optimal
Page 75 and 76: β β β 8 6 4 2 h π =0 0 0 0.5 1
Page 77 and 78: Table 11: Characteristics and Perfo
Page 79 and 80: Table 12: Characteristics and Perfo
Page 81 and 82: are even less robust than the outco
Page 83 and 84: Bernanke, B. S., 2009. Federal Rese
Page 85 and 86: Edge, R. M., Kiley, M. T., Laforte,
Page 87 and 88: Hargreaves, D., 1999. SDS-FPS: A sm
Page 89 and 90: Rotemberg, J. J., Woodford, M., 199
Page 91 and 92: Wieland, V., 2010. Quantitative eas
Page 93 and 94: new capital becomes effective with
Page 95:
6 4 2 0 −2 −2 7 6 5 4 3 2 Forec
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