Wednesday, July 18, 2012

How to report Fed uncertainty

Any good research reports qualifications and uncertainties about the results. Unfortunately, the non-scientific reader is not interested in those, he wants certainties. A good example is the issue of global climate change. Of course there is some uncertainty about it, but climate scientists did not report it because the public would otherwise discredit their findings. And indeed, once it was "revealed" global climate change is not 100% sure, an uproar resulted. It is not different in Economics.

Recently, the US Federal Reserve started publishing the differences of opinion of its FOMC members regarding its forecasts. There are good reasons for that. The market needs to understand when policy may change course because the data do not tell us enough about the future course. But will the public actually listen to this piece of information? Ray Fair does not think so because the wrong information is disseminated. Indeed, the dispersion of median forecasts has rather little information, especially if there is the group think the Board is sometimes accused of, compared to the statistical variance in the forecasts of a single model. Using historical errors as a basis, one could simulate whatever model(s) the Fed uses, draw out for each potential future history policy reactions, and then report the dispersion in future federal fund rates. Much better than the current dispersion of median opinions. And maybe the public will look at it.

1 comment:

Anonymous said...

Good luck with that. I have prepared forecasts for financial institution, complete with error bands, and they completely disregard these details. All they want is what an particular interest rate is going to be one year ahead, with a precise number. And the only acknowledgment about forecasting uncertainty is that they tolerate a forecasting error of less than 25 points...

Needless to say, I do not do these forecasts any more. Too disheartening and frustrating.