Forecasting Inflation and Growth: Do Private Forecasts Match Those of Policymakers?

Generally, we value forecasts for their accuracy. In some cases, however, the forecasts themselves are interesting because of what they reveal about the forecaster. Monetary policymaker forecasts are important because they partially reveal what policymakers believe will follow from their decisions. Forecasts of inflation and real output (whether made by Federal Reserve officials or private sector economists) contain information that is important for changing the stance of monetary policy. Market participants generally believe that Fed policymakers will change their policy stance if the economy appears to be headed in a different direction from what was expected at the time policy was adopted. Svensson (1997) and Svensson and Woodford (2000) explain why a central bank might want to target its inflation forecast. The intuition in their explanation is that policymakers should look at everything that is relevant when deciding to change the policy stance. The trouble with looking at everything is that there is so much information to process, one needs an organizing framework such as a forecasting model. Forecasting models are developed to monitor incoming information and to weigh each piece appropriately. Forecasting models range from the very largest, with over a thousand equations, to small models that are no more than simple rules of thumb. Whether using a large econometric model or a simple rule of thumb, forecasters rarely use the values that come directly from the model. Rather, they typically make judgmental adjustments before reporting the forecasts. In this article, we examine the role of forecasts in the monetary policy process. Our focus is on the forecasts of inflation and economic growth, the main policy objectives. Economic forecasts are important because they reflect incoming information about the current state of the economy, including the forecasters’ beliefs about monetary policy objectives. In the United States, there are no explicit numerical objectives for output and inflation. Thus, policymaker forecasts are particularly interesting because they may reveal information about long-run policy goals. Fed forecasts, unfortunately, are not readily available to the public. We show that the Blue Chip consensus forecasts, made by a group of private economists, are a good stand-in for the policymakers’ forecasts. This is important because the policymakers in the Federal Reserve, the members of the Federal Open Market Committee (FOMC), reveal their forecasts only sparingly and after policy decisions are made. First, we show how well the forecasts match. We find that the forecasts of economic growth are very similar and appear to be about equal on average. The result for inflation forecasts is more interesting. Here we see that the private sector economists generally predicted higher inflation than did Fed policymakers, especially in the 1980s. The Blue Chip economists did not believe that the FOMC would achieve and maintain such a low inflation rate in the 1980s. Since 1995, the forecasts have converged. Evidently, the FOMC has achieved some credibility with the Blue Chip economists. When researchers want to know the history of policymakers’ forecasts, they typically go to the Fed’s briefing documents to extract the forecasts of the research staff at the Board of Governors. We show that the Blue Chip forecasts for output are as good a proxy for Fed policymakers’ views as are the research staff forecasts. In the case of inflation, the results vary with the time horizon. Generally, the Blue Chip consensus forecasts for inflation match the policymakers’ forecasts at shorter horizons while the research staff forecasts are closer at the longest horizon. Finally, we examine the use of alternative forecasts in a version of the Taylor rule, a popular characterization of monetary policy actions. It is popular because it is a simple summary of a complicated policy process. It is expressed as: