Tara Sinclair, Pao-Lin Tien, & Edward N. Gamber
Abstract: In order to make forward-looking policy decisions, the Fed relies on imperfect forecasts of future macroeconomic conditions. If the Fed’s forecasts are rational, then the difference between the actual outcome and the Fed’s forecast can be treated as an exogenous shock. We investigate the effect of the Fed’s forecast errors on output and price movements under the assumption that the Fed intends to implement policy through a forward-looking Taylor rule with perfect foresight. Our results suggest that although the absolute magnitude of the Fed’s forecast error shock is large, the impact of the shock on the macroeconomy is reassuringly small.
Keywords: Federal Reserve, Taylor rule, forecast evaluation, monetary policy shocks
JEL Classification: E32; E31; E52; E58