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USING FORECASTS TO UNCOVER THE LOSS FUNCTION OF FEDERAL OPEN MARKET COMMITTEE MEMBERS

Published online by Cambridge University Press:  06 January 2016

Christian Pierdzioch ,
Jan-Christoph Rülke  and
Peter Tillmann
Christian Pierdzioch
Affiliation:
Helmut-Schmidt-University
Jan-Christoph Rülke*
Affiliation:
EBS—Universität für Wirtschaft und Recht
Peter Tillmann
Affiliation:
Justus-Liebig-University Giessen
*
Address correspondence to: Jan-Christophe Rülke, Department of Management and Economics, EBS—Business School, Rheingaustrasse 1, D-65375 Oestrich-Winkel, Germany; e-mail: [email protected].
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Abstract

We revisit the sources of the bias in Federal Reserve forecasts and assess whether a precautionary motive can explain the forecast bias. In contrast to the existing literature, we use forecasts submitted by individual Federal Open Market Committee (FOMC) members to uncover members' implicit loss function. Our key finding is that the loss function of FOMC members is asymmetric: FOMC members incur a higher loss when they underpredict (overpredict) inflation and unemployment (nominal and real growth) as compared to their making an overprediction (underprediction) of similar size. We also find that an asymmetric loss function, in some cases, weakens evidence against forecast rationality, though results depend on the variable being projected and the subgroup of FOMC members being studied. Furthermore, we add to the recent controversy on the relative quality of FOMC forecasts compared to staff forecasts. Our results suggest that differences in predictive ability could indeed stem from differences in preferences.

Keywords

Federal Open Market CommitteeForecastingAsymmetric Loss FunctionMonetary Policy
Type
Articles
Information
Macroeconomic Dynamics , Volume 20 , Issue 3 , April 2016 , pp. 791 - 818
Copyright
Copyright © Cambridge University Press 2016 

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