nep-for New Economics Papers
on Forecasting
Issue of 2005‒10‒04
25 papers chosen by
Rob J Hyndman
Monash University

  1. Forecasting macroeconomic variables for the new member states of the European Union By Anindya Banerjee; Massimiliano Marcellino; Igor Masten
  2. Forecasting with a Bayesian DSGE model - an application to the euro area By Frank Smets; Raf Wouters
  3. Does the yield spread predict recessions in the euro area? By Fabio Moneta
  4. Early-warning tools to forecast general government deficit in the euro area: the role of intra-annual fiscal indicators By Javier J. Pérez
  5. To aggregate or not to aggregate? Euro area inflation forecasting By Nicholai Benalal; Juan Luis Diaz del Hoyo; Bettina Landau; Moreno Roma; Frauke Skudelny
  6. Forecasting euro area inflation using dynamic factor measures of underlying inflation By Gonzalo Camba-Méndez; George Kapetanios
  7. Modelling inflation in the euro area By Eilev S. Jansen
  8. Monetary policy predictability in the euro area: an international comparison By Bjørn-Roger Wilhelmsen; Andrea Zaghini
  9. Optimal monetary policy rules for the euro area: an analysis using the area wide model By Alistair Dieppe; Keith Küster; Peter McAdam
  10. An Essay on the Interactions between the Bank of England's Forecasts, The MPC's Policy Adjustments, and the Eventual Outcome By Charles Goodhart
  11. Option-implied asymmetries in bond market expectations around monetary policy actions of the ECB By Sami Vähämaa
  12. Explicit inflation objectives and macroeconomic outcomes By Andrew T. Levin; Fabio M. Natalucci; Jeremy M. Piger
  13. Forecasting inflation with thick models and neural networks By Paul McNelis; Peter McAdam
  14. Calvo pricing and imperfect common knowledge: a forward looking model of rational inflation inertia By Rolf Strauch; Mark Hallerberg; Jürgen von Hagen
  15. A structural common factor approach to core inflation estimation and forecasting By Claudio Morana
  16. Indeterminacy with inflation-forecast-based rules in a two-bloc model. By Nicoletta Batini; Paul Levine; Joseph Pearlman
  17. The Phillips curve and long-term unemployment By Ricardo Llaudes
  18. On the fit and forecasting performance of New-Keynesian models By Marco Del Negro; Frank Schorfheide; Frank Smets; Raf Wouters
  19. Foreign exchange option and returns based correlation forecasts - evaluation and two applications By Olli Castrén; Stefano Mazzotta
  20. The information content of over-the-counter currency options By Peter Christoffersen; Stefano Mazzotta
  21. Yield curve prediction for the strategic investor By Carlos Bernadell; Joachim Coche; Ken Nyholm
  22. Do Dollar Forecasters Believe too Much in PPP? By Menkhoff, Lukas; Rebitzky, Rafael; Schröder, Michael
  23. Monetary policy with judgment - forecast targeting By Lars E. O. Svensson
  24. Central bank transparency and private information in a dynamic macroeconomic model By Joseph G. Pearlman
  25. A joint econometric model of macroeconomic and term structure dynamics By Peter Hördahl; Oreste Tristani; David Vestin

  1. By: Anindya Banerjee (Corresponding author: Department of Economics, European University Institute, Via della Piazzuola, 43, 50133 Firenze, Italy); Massimiliano Marcellino (IEP-Bocconi University, IGIER, and CEPR,Via Salasco, 5, 20136, Milano, Italy); Igor Masten (Faculty of Economics, University of Ljubljana, Kardeljeva ploscad 17, 1000, Ljubljana, Slovenia)
    Abstract: The accession of ten countries into the European Union makes the forecasting of their key macroeconomic indicators an exercise of some importance. Because of the transition period, only short spans of reliable time series are available, suggesting the adoption of simple time series models as forecasting tools. However, despite this constraint on the span of data, a large number of macroeconomic variables (for a given time span) are available, making the class of dynamic factor models a reasonable alternative forecasting tool. The relative performance of these two forecasting approaches is compared by using data for five new Member States. The role of Euro-area information for forecasting and the usefulness of robustifying techniques such as intercept corrections are also evaluated. We find that factor models work well in general, although with marked differences across countries. Robustifying techniques are useful in a few cases, while Euro-area information is virtually irrelevant.
    Keywords: Factor models; forecasts; time series models; new Member States.
    JEL: C53 C32 E37
    Date: 2005–05
  2. By: Frank Smets (European Central Bank, CEPR and University of Ghent.); Raf Wouters (National Bank of Belgium.)
    Abstract: In monetary policy strategies geared towards maintaining price stability conditional and unconditional forecasts of inflation and output play an important role. This paper illustrates how modern sticky-price dynamic stochastic general equilibrium models, estimated using Bayesian techniques, can become an additional useful tool in the forecasting kit of central banks. First, we show that the forecasting performance of such models compares well with a-theoretical vector autoregressions. Moreover, we illustrate how the posterior distribution of the model can be used to calculate the complete distribution of the forecast, as well as various inflation risk measures that have been proposed in the literature. Finally, the structural nature of the model allows computing forecasts conditional on a policy path. It also allows examining the structural sources of the forecast errors and their implications for monetary policy. Using those tools, we analyse macroeconomic developments in the euro area since the start of EMU.
    Keywords: Forecasting; DSGE models; monetary policy; euro area.
    JEL: E4 E5
    Date: 2004–09
  3. By: Fabio Moneta (Finance Department, Carroll School of Management, Boston College, 140 Commonwealth Avenue, Chestnut Hill, MA 02467-3808.)
    Abstract: This paper studies the informational content of the slope of the yield curve as a predictor of recessions in the euro area. In particular, the historical predictive power of ten yield spreads, for different segments of the yield curve, is tested using a probit model. The yield spread between the ten-year government bond rate and the threemonth interbank rate outperforms all the other spreads in predicting recessions in the euro area. The result is confirmed when the autoregressive series of the state of the economy is added in the same model. The forecast accuracy of the spread between 10-year and 3-month interest rates is explored in an exercise of out-of-sample forecasting. This yield spread appears to contain information which goes beyond the information already available in the history of output, providing further evidence of the potential usefulness of this indicator for monetary policy purposes.
    Keywords: Probit model; forecasting; recessions; yield curve.
    JEL: E44 E52 C53
    Date: 2003–12
  4. By: Javier J. Pérez (Centro de Estudios Andaluces (centrA), c/ Bailén 50, 41001 Seville, Spain)
    Abstract: In this paper I evaluate the usefulness of a set of fiscal indicators as early-warning-signal tools for annual General Government Net Lending developments for some EMU countries (Belgium, Germany, Spain, France, Italy, The Netherlands, Ireland, Austria, Finland) and an EMU aggregate. The indicators are mainly based on monthly and quarterly public accounts’ figures. I illustrate how the dynamics of the indicators show a remarkable performance when anticipating general government accounts’ movements, both in qualitative and in quantitative terms.
    Keywords: Leading indicators; Fiscal forecasting and monitoring; General Government Deficit; European Monetary Union.
    JEL: C53 E6 H6
    Date: 2005–06
  5. By: Nicholai Benalal (European Central Bank, Directorate General Economics); Juan Luis Diaz del Hoyo (European Central Bank, Directorate General Economics); Bettina Landau (European Central Bank, Directorate General Economics); Moreno Roma (European Central Bank, Directorate General Economics); Frauke Skudelny (European Central Bank, Directorate General Economics)
    Abstract: In this paper we investigate whether the forecast of the HICP components (indirect approach) improves upon the forecast of overall HICP (direct approach) and whether the aggregation of country forecasts improves upon the forecast of the euro-area as a whole, considering the four largest euro area countries. The direct approach provides clearly better results than the indirect approach for 12 and 18 steps ahead for the overall HICP, while for shorter horizons the results are mixed. For the euro area HICP excluding unprocessed food and energy (HICPX), the indirect forecast outperforms the direct whereas the differences are only marginal for the countries. The aggregation of country forecasts does not seem to improve upon the forecast of the euro area HICP and HICPX. This result has however to be taken with caution as differences appear to be rather small and due to the limited country coverage.
    Keywords: Forecasting short-term inflation, HICP sub-components/aggregation, Bayesian VARs, Model Selection
    JEL: C11 C32 C53 E31 E37
    Date: 2004–07
  6. By: Gonzalo Camba-Méndez (Corresponding author. European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.); George Kapetanios (Department of Economics, Queen Mary, University of London, Mile End Road, London E1 4N, United Kingdom.)
    Abstract: Standard measures of prices are often contaminated by transitory shocks. This has prompted economists to suggest the use of measures of underlying inflation to formulate monetary policy and assist in forecasting observed inflation. Recent work has concentrated on modelling large datasets using factor models. In this paper we estimate factors from datasets of disaggregated price indices for European countries. We then assess the forecasting ability of these factor estimates against other measures of underlying inflation built from more traditional methods. The power to forecast headline inflation over horizons of 12 to 18 months is adopted as a valid criterion to assess forecasting. Empirical results for the five largest euro area countries as well as for the euro area are presented.
    Keywords: Core Inflation; Dynamic Factor Models; Forecasting.
    JEL: E31 C13 C32
    Date: 2004–11
  7. By: Eilev S. Jansen (Norges Bank, Norwegian University of Science and Technology)
    Abstract: The paper presents an incomplete competition model (ICM), where inflation is determined jointly with unit labour cost growth. The ICM is estimated on data for the Euro area and evaluated against existing models, i.e. the implicit inflation equation of the Area Wide model (AWM) - cf. Fagan, Henry and Mestre (2001) - and estimated versions of the (single equation) P* model and a hybrid New Keynesian Phillips curve. The evidence from these comparisons does not invite decisive conclusions. There is, however, some support in favour of the (reduced form) AWM inflation equation. It is the only model that encompasses a general unrestricted model and it forecast encompasses the competitors when tested on 20 quarters of one step ahead forecasts.
    Keywords: Bayesian Analysis; DSGE Models; Model Misspecification.
    JEL: C32
    Date: 2004–03
  8. By: Bjørn-Roger Wilhelmsen (Norges Bank, Bankplassen 2, 0107 Oslo, Norway); Andrea Zaghini (Banca d’Italia, Servizio Studi, Via Nazionale 91, 00184 Roma, Italy)
    Abstract: The paper evaluates the ability of market participants to anticipate monetary policy decisions in the euro area and in 13 other countries. First, by looking at the magnitude and the volatility of the changes in the money market rates we show that the days of policy meetings are special days for financial markets. Second, we find that the predictability of the ECB’s monetary policy is fully comparable (and sometimes slightly better) to that of the FED and the Bank of England. Finally, an econometric analysis of the ability of market participants to incorporate in the current money rates the expected changes in the key policy rate shows that in the euro area policy decisions are anticipated well in advance.
    Keywords: Monetary policy; Predictability; Money market rates.
    JEL: E4 E5 G1
    Date: 2005–07
  9. By: Alistair Dieppe (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Keith Küster (Chair for Monetary Theory and Policy, Johann Wolfgang Goethe-University Postbox 94, D-60054 Frankfurt/Main.); Peter McAdam (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: In this paper, we analyze optimal monetary policy rules in a model of the euro area, namely the ECB’s Area Wide Model, which embodies a high degree of intrinsic persistence and a limited role for forward-looking expectations. These features allow us, in large measure, to differentiate our results from many of those prevailing in New Keynesian paradigm models. Specifi- cally, our exercises involve analyzing the performance of various generalized Taylor rules both from the literature and optimized to the reference model. Given the features of our modelling framework, we find that optimal policy smoothing need only be relatively mild. Furthermore, there is substantial gain from implementing forecast-based as opposed to outcome-based policies with the optimal forecast horizon for inflation ranging between two and three years. Benchmarking against fully optimal policies, we further highlight that the gain of additional states in the rule may compensate for a reduction of communicability. Thus, the paper contributes to the debate on optimal monetary policy in the euro area, as well as to the conduct of monetary policy in face of substantial persistence in the transmission mechanism.
    Keywords: euro area; monetary policy rule; optimization.
    JEL: E4 E5
    Date: 2004–05
  10. By: Charles Goodhart
    Abstract: No abstract available.
    Date: 2005–10
  11. By: Sami Vähämaa (University of Vaasa, Department of Accounting and Finance, P.O. Box 700, FIN-65101 Vaasa, Finland;)
    Abstract: This paper uses data on German government bond futures options to examine the behaviour of market expectations around monetary policy actions of the European Central Bank (ECB). In particular, this paper focuses on the asymmetries in bond market expectations, as measured by the skewness of option-implied probability distributions of future bond yields. The results show that market expectations are systematically asymmetric around monetary policy actions of the ECB. Around monetary policy tightening, option-implied yield distributions are positively skewed, indicating that market participants attach higher probabilities for sharp yield increases than for sharp decreases. Correspondingly, around loosening of the policy, implied yield distributions are negatively skewed, suggesting that markets assign higher probabilities for sharp yield decreases than for increases. Furthermore, the results indicate that market expectations are significantly altered around monetary policy actions, as asymmetries in market expectations tend to increase before changes in the monetary policy stance, and to decrease afterwards.
    Keywords: Market expectations; Asymmetries; Implied skewness; Monetary policy.
    JEL: E44 E52 G10 G13
    Date: 2004–03
  12. By: Andrew T. Levin (Federal Reserve Board of Governors); Fabio M. Natalucci (Federal Reserve Board of Governors); Jeremy M. Piger (Federal Reserve Bank of St. Louis, Research Department)
    Abstract: We find evidence that adopting an explicit inflation objective plays a role in anchoring long-run inflation expectations and in reducing the intrinsic persistence of inflation. For the period 1994-2003, private-sector long-run inflation forecasts exhibit significant correlation with lagged inflation for a number of industrial economies, including the United States. In contrast, this correlation is largely absent for the five countries that maintained explicit inflation objectives over this period, indicating that these central banks have been reasonably successful in delinking expectations from realized inflation. We also show that the null hypothesis of a random walk in core CPI inflation can be clearly rejected for four of these five countries, but not for most of the other industrial countries. Finally, we provide some evidence concerning the initial effects of the adoption of explicit inflation objectives in a number of emerging-market economies.
    Keywords: Inflation expectations, Consensus Forecasts, inflation persistence.
    JEL: E31 E52 E58
    Date: 2004–08
  13. By: Paul McNelis (Department of Economics, Georgetown University,Washington, DC 20057); Peter McAdam (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt/Main, Germany.)
    Abstract: This paper applies linear and neural network-based “thick” models for forecasting inflation based on Phillips–curve formulations in the USA, Japan and the euro area. Thick models represent “trimmed mean” forecasts from several neural network models. They outperform the best performing linear models for “real-time” and “bootstrap” forecasts for service indices for the euro area, and do well, sometimes better, for the more general consumer and producer price indices across a variety of countries.
    Keywords: Neural Networks; Thick Models; Phillips curves; real-time forecasting; bootstrap.
    JEL: C12 E31
    Date: 2004–04
  14. By: Rolf Strauch (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt/Main, Germany); Mark Hallerberg (Emory University, Department of Political Science, 201 Dowman Drive, Atlanta, GA 30322.); Jürgen von Hagen (ZEI Zentrum für Europäische Integrationsforschung /Center for European Integration Studies, Rheinische Friedrich-Wilhelms-Universität Bonn)
    Abstract: We analyse the performance of budgetary and growth forecasts of all stability and convergence programmes submitted by EU member states over the last decade. Differences emerge for the bias in budgetary projections across countries. As a second step we explore whether economic, political and institutional factors can explain this pattern. Our analysis indicates that the cyclical position and the form of fiscal governance are major determinants of forecast biases. Projected changes in the budgetary position are mainly affected by the cycle, the need of convergence before EMU and by electoral cycles.
    Keywords: Fiscal forecasting; Forecast evaluation; Budget processes; Stability and Growth Pact.
    JEL: C53 E17 H62
    Date: 2004–02
  15. By: Claudio Morana (University of Piemonte Orientale, Faculty of Economics, Via Perrone 18, I-28100, Novara, Italy)
    Abstract: In the paper we propose a new methodological approach to core inflation estimation,based on a frequency domain principal components estimator, suited to estimate systems of fractionally cointegrated processes. The proposed core inflation measure is the scaled common persistent factor in inflation and excess nominal money growth and bears the interpretation of monetary inflation. The proposed measure is characterised by all the properties that an “ideal” core inflation process should show, providing also a superior forecasting performance relative to other available measures.
    Keywords: Long memory; Common factors; Fractional cointegration; Markov switching; Core inflation; Euro area.
    JEL: C22 E31 E52
    Date: 2004–02
  16. By: Nicoletta Batini (Research Adviser, MPC Unit, Bank of England,Threadneedle Street, London EC2R 8AH, United Kingdom.); Paul Levine (Professor of Economics, University of Surrey, Guildford, Surrey GU2 7XH, United Kingdom.); Joseph Pearlman (Professor of Economics, London Metropolitan University, 31 Jewry St, London EC3N 2EY, United Kingdom.)
    Abstract: We examine the performance of forward-looking inflation-forecast-based rules in open economies. In a New Keynesian two-bloc model, a methodology first employed by Batini and Pearlman (2002) is used to obtain analytically the feedback parameters/horizon pairs associated with unique and stable equilibria. Three key findings emerge: first, indeterminacy occurs for any value of the feedback parameter on inflation if the forecast horizon lies too far into the future. Second, the problem of indeterminacy is intrinsically more serious in the open economy. Third, the problem is compounded further in the open economy when central banks respond to expected consumer, rather than producer price inflation.
    Keywords: Taylor rules; inflation-forecast-based rules; indeterminacy; open economy.
    JEL: E52 E37 E58
    Date: 2004–04
  17. By: Ricardo Llaudes (The Johns Hopkins University, Department of Economics, 3400 N. Charles Street, Baltimore, MD 21218, USA.)
    Abstract: This paper studies the role of long-term unemployment in the determination of prices and wages. Labor market theories such as insider-outsider models predict that this type of unemployed are less relevant in the wage formation process than the newly unemployed. This paper looks for evidence of this behavior in a set of OECD countries. For this purpose, I propose a new specification of the Phillips Curve that contains different unemployment lengths in a time-varying NAIRU setting. This is done by constructing an index of unemployment that assigns different weights to the unemployed based on the length of their spell. The results show that unemployment duration matters in the determination of prices and wages, and that a smaller weight ought to be given to the long-term unemployed. This modified model has important implications for the policy maker: It produces more accurate forecasts of inflation and more precise estimates of the NAIRU.
    Keywords: Long-term unemployment; Phillips curve; NAIRU; Kalman filter.
    JEL: C22 E31 E50 J64
    Date: 2005–02
  18. By: Marco Del Negro (Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street N.E., Atlanta, GA 30309-4470, USA); Frank Schorfheide (University of Pennsylvania, Department of Economics, 3718 Locust Walk, Philadelphia, PA 19 104, USA); Frank Smets (European Central Bank and CEPR); Raf Wouters (National Bank of Belgium, B-1000 Brussels, Belgium)
    Abstract: The paper provides new tools for the evaluation of DSGE models, and applies it to a large-scale New Keynesian dynamic stochastic general equilibrium (DSGE) model with price and wage stickiness and capital accumulation. Specifically, we approximate the DSGE model by a vector autoregression (VAR), and then systematically relax the implied cross-equation restrictions. Let Lambda denote the extent to which the restrictions are being relaxed. We document how the in- and out-of-sample fit of the resulting specification (DSGE-VAR) changes as a function of Lambda. Furthermore, we learn about the precise nature of the misspecification by comparing the DSGE model’s impulse responses to structural shocks with those of the best-fitting DSGEVAR. We find that the degree of misspecification in large-scale DSGE models is no longer so large to prevent their use in day-to-day policy analysis, yet it is not small enough that it cannot be ignored.
    Keywords: Bayesian Analysis; DSGE Models; Model Evaluation; Vector Autoregressions.
    JEL: C11 C32 C53
    Date: 2005–06
  19. By: Olli Castrén (Corresponding author: DG-Economics, European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Stefano Mazzotta (McGill University - Faculty of Management, 1001 Sherbrooke St.West, Montreal, Quebec H3A1G5, Canada.)
    Abstract: We compare option-implied correlation forecasts from a dataset consisting of over 10 years of daily data on over-the-counter (OTC) currency option prices to a set of return-based correlation measures and assess the relative quality of the correlation forecasts. We find that while the predictive power of implied correlation is not always superior to that of returns based correlations measures, it tends to provide the most consistent results across currencies. Predictions that use both implied and returns-based correlations generate the highest adjusted R2s, explaining up to 42 per cent of the realised correlations. We then apply the correlation forecasts to two policyrelevant topics, to produce scenario analyses for the euro effective exchange rate index, and to analyse the impact on cross-currency co-movement of interventions on the JPY/USD exchange rate.
    Keywords: Correlation forecasts; currency options data; effective exchange rate.
    JEL: F31 G15
    Date: 2005–02
  20. By: Peter Christoffersen (Faculty of Management, McGill University); Stefano Mazzotta (Department of Economics & Finance, Coles College of Business, Kennesaw State University)
    Abstract: Financial decision makers often consider the information in currency option valuations when making assessments about future exchange rates. The purpose of this paper is to systematically assess the quality of option based volatility, interval and density forecasts. We use a unique dataset consisting of over 10 years of daily data on over-the-counter currency option prices. We find that the OTC implied volatilities explain a much larger share of the variation in realized volatility than previously found using market-traded options. Finally, we find that wide-range interval and density forecasts are often misspecified whereas narrow-range interval forecasts are well specified.
    Keywords: FX, Volatility, Interval, Density, Forecasting.
    JEL: G13 G14 C22 C53
    Date: 2004–06
  21. By: Carlos Bernadell (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt am Main, Germany); Joachim Coche (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt am Main, Germany); Ken Nyholm (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt am Main, Germany)
    Abstract: This paper presents a new framework allowing strategic investors to generate yield curve projections contingent on expectations about future macroeconomic scenarios. By consistently linking the shape and location of yield curves to the state of the economy our method generates predictions for the full yield-curve distribution under different assumptions on the future state of the economy. On the technical side, our model represents a regimeswitching expansion of Diebold and Li (2003) and hence rests on the Nelson-Siegel functional form set in state-space form. We allow transition probabilities in the regimeswitching set-up to depend on observed macroeconomic variables and thus create a link between the macro economy and the shape and location of yield curves and their time-series evolution. The model is successfully applied to US yield curve data covering the period from 1953 to 2004 and encouraging out-of-sample results are obtained, in particular at forecasting horizons longer than 24 months.
    Keywords: Regime switching; scenario analysis; yield curve distributions; state space model.
    JEL: C51 C53 E44
    Date: 2005–04
  22. By: Menkhoff, Lukas; Rebitzky, Rafael; Schröder, Michael
    Abstract: This paper extends earlier studies on exchange rate expectations' formation by using new data and adding information about forecasters' reliance on fundamental analysis for the first time. We replicate the conventional result of non rational expectations. Moreover, biases in expectations are identified as professionals significantly belief too much in mean reversion, mean being represented by PPP. When respondents are grouped on their reliance to fundamental analysis, fundamentalists reveal an even stronger bias. Those, who rely the least on fundamentals preferring technical analysis instead , show a significantly smaller bias towards PPP in lieu of expecting too much trend extrapolation. Biased beliefs will grow stronger when the US Dollar is further away from PPP. Finally, the accuracy of the expectations is poor for both groups however we find directional forecasting ability.
    Keywords: Exchange rate expectations, forecasting, fundamental analysis, technical analysis, purchasing power parity
    JEL: F31 G14
    Date: 2005–09
  23. By: Lars E. O. Svensson (Department of Economics, Fischer Hall, Princeton University, Princeton, NJ 08544-1021, United States)
    Abstract: “Forecast targeting,” forward-looking monetary policy that uses central-bank judgment to construct optimal policy projections of the target variables and the instrument rate, may perform substantially better than monetary policy that disregards judgment and follows a given instrument rule. This is demonstrated in a few examples for two empirical models of the U.S. economy, one forward looking and one backward looking. A practical finite-horizon approximation is used. Optimal policy projections corresponding to the optimal policy under commitment in a timeless perspective can easily be constructed. The whole projection path of the instrument rate is more important than the current instrument setting. The resulting reduced-form reaction function for the current instrument rate is a very complex function of all inputs in the monetary-policy decision process, including the central bank’s judgment. It cannot be summarized as a simple reaction function such as a Taylor rule. Fortunately, it need not be made explicit.
    Keywords: Inflation targeting; optimal monetary policy; forecasts.
    JEL: E42 E52 E58
    Date: 2005–04
  24. By: Joseph G. Pearlman (London Metropolitan University – Department of Economics, Finance and International Business (EFIB), 84 Morgate, London EC2M 6SQ, United Kingdom.)
    Abstract: We investigate the role of economic transparency within the framework of one of Townsend’s models of ‘forecasting the forecasts of others’. The equilibrium has the property that ‘higher order beliefs’ are coordinated into a finite-dimensional setup that is amenable to address monetary policy issues. We focus here on the role of public information about the money supply, and find that it should be fully revealing.
    Keywords: Transparency; central banks; asymmetric information; public information.
    JEL: D82 E58
    Date: 2005–03
  25. By: Peter Hördahl (DG Research, European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Oreste Tristani (Corresponding author: DG Research, European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); David Vestin (DG Research, European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We construct and estimate a joint model of macroeconomic and yield curve dynamics. A small-scale rational expectations model describes the macroeconomy. Bond yields are affine functions of the state variables of the macromodel, and are derived assuming absence of arbitrage opportunities and a flexible price of risk specification. While maintaining the tractability of the affine set-up, our approach provides a way to interpret yield dynamics in terms of macroeconomic fundamentals; time-varying risk premia, in particular, are associated with the fundamental sources of risk in the economy. In an application to German data, the model is able to capture the salient features of the term structure of interest rates and its forecasting performance is often superior to that of the best available models based on latent factors. The model has also considerable success in accounting for features of the data that represent a puzzle for the expectations hypothesis.
    Keywords: Affine term-structure models; policy rules; new neo-classical synthesis.
    JEL: E43 E44 E47
    Date: 2004–11

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