Maik Wolters

Forecasting and Policy Making

Policymakers use forecasts to project the consequences of particular policy decisions for certain policy targets. This chapter investigates the use of economic forecasting in policy making by discussing practical examples, providing new empirical evidence and computing forecasts using different macroeconomic models. First, a theoretical framework is presented to differentiate the role of forecasts in simple feedback rules, optimal control policies, and forecast targeting. Then, we review institutional details of the forecasting process at fiscal authorities and central banks. We provide empirical evidence that central bank policy rate decisions in the United States and the Euro area are well described by interest rate rules responding to forecasts of inflation and economic activity rather than recent outcomes. Next, we provide a detailed exposition of methods for producing forecasts. We review forecasting models and provide practical applications. In particular, we illustrate how to use economic structure in interpreting forecasts and how to implement different conditioning assumptions regarding certain planned policy initiatives. Finally, we evaluate the accuracy of central bank and expert forecasts and investigate the interaction between forecasting and policy making by evaluating the performance and robustness of forecast-based policy rules under model uncertainty.

Evaluating Point and Density Forecasts of DSGE Models

This paper investigates the accuracy of point and density forecasts of four DSGE models for inflation, output growth and the federal funds rate. Model parameters are estimated and forecasts are derived successively from historical U.S. data vintages synchronized with the Fed’s Greenbook projections. Point forecasts of some models are of similar accuracy as the forecasts of nonstructural large dataset methods. Despite their common underlying New Keynesian modeling philosophy, forecasts of different DSGE models turn out to be quite distinct. Weighted forecasts are more precise than forecasts from individual models. The accuracy of a simple average of DSGE model forecasts is comparable to Greenbook projections for medium term horizons. Comparing density forecasts of DSGE models with the actual distribution of observations shows that the models overestimate uncertainty around point forecasts.

Estimating Monetary Policy Reaction Functions Using Quantile Regressions

Monetary policy rule parameters are usually estimated at the mean of the interest rate distribution conditional on inflation and an output gap. This is an incomplete description of monetary policy reactions when the parameters are not uniform over the conditional distribution of the interest rate. I use quantile regressions to estimate parameters over the whole conditional distribution of the Federal Funds Rate. Inverse quantile regressions are applied to deal with endogeneity. Realtime data of inflation forecasts and the output gap are used. I find significant and systematic variations of parameters over the conditional distribution of the interest rate.

Is Globalization Reducing the Ability of Central Banks to Control Inflation? A Literature Review with an Application to the Euro Area

Abstract Globalization influences inflation and the transmission channels of monetary policy in various ways. The effects of globalization on the ability of monetary policy to control inflation have been discussed intensively. However, in the light of recent experiences following the global financial crisis with extended periods of disinflation in many advanced economies, the question whether the ability of monetary policy to control inflation has suffered significantly from increasing globalization has received new relevance. Based on a review of the literature, this paper discusses whether globalization is reducing the ability of central banks to control inflation and draws conclusion for the current situation in the euro area. We find that globalization has made it more complicated for central banks to ensure price stability and that it has tended to reduce the ability of monetary policy to control inflation in the short- to medium-run. However, in principle the ECB is still able to control inflation but may have to tolerate deviations from its inflation target for somewhat longer periods.