Wednesday, January 30, 2013

The Fed is very good at forecasting inflation, obviously

There was a time where central banks liked to surprise markets. Macroeconomic theory dictated then that central banks should be secretive and could only be effective if they could fool the market's expectations or play on the fact they have some privileged information. After the disastrous inflation of the 1970's, central banks have completely reverse course and are now models of openness. They go as far as publishing their economic forecasts, even with various scenarios, explain in great detail their policy, in some cases even publishing the Taylor rule they follow. Is there still some asymmetric information left? If central banks still manage to forecast information better than markets, then yes.

Bedri Kamil Onur Tas uses the Fed's Green Book forecasts for inflation and the federal funds rate, which are released with a five year delay, to find that the reason the Fed has better forecasts is that its FFR forecasts, which is its own policy instrument, are used and are better than the market's forecasts of the FFR. What this long sentence means is that the Fed knows better its future policy stance, and it uses this efficiently in its inflation forecast. What this also means is that the Fed could still improve the way it communicates its policy intentions.

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