For release: May 9, 2001
Contact: Charles B. Henderson, (314) 444-8311

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

ST. LOUIS -- In the 1980s, economists in the private sector predicted higher inflation than the Federal Reserve's policymakers did. Since 1995, however, the two forecasts have been more in synch, suggesting that the Federal Open Market Committee (FOMC), the Fed's policymaking arm, has achieved some credibility in controlling inflation.

That's the conclusion of two researchers at the Federal Reserve Bank of St. Louis, William T. Gavin and Rachel J. Mandal. Their analysis appears in the May/June issue of Review, the St. Louis Fed's bimonthly journal of business and economic issues.

"Forecasts of inflation and real output (GDP)--whether by Federal Reserve officials or private sector economists--contain information that is important for changing the stance of monetary policy," said Gavin and Mandal. "Fed watchers believe that the FOMC will change their policy stance if the economy appears to be headed in a different direction from what was expected at the time the policy was adopted.

While noting that forecasts are valued for their accuracy, Gavin and Mandal acknowledged that the forecasts themselves are interesting because of what they reveal about the forecaster. "Forecasts by monetary policymakers are important because they partially reveal what policymakers believe will follow from their decisions," they said.

Fed forecasts, however, are not readily available to the public. Gavin and Mandal showed that Blue Chip consensus forecasts (made monthly by a group of private sector economists) may be a good stand-in for the FOMC's semi-annual forecasts.

Gavin and Mandal also examined the use of alternative forecasts in a version of the so-called Taylor Rule, a popular characterization of monetary policy actions. The Taylor Rule prescribes settings for the federal funds rate (the Fed's short-term policy instrument), according to a deviation of the past year's inflation from a 2 percent target and the deviation of last period's GDP from a measure of potential GDP. In addition, they examined a modified version of Taylor's Rule that includes past values of inflation and the output gap as well as the Blue Chip forecasts of the current-year inflation and output gap.

Gavin and Mandal found that there did not seem to be any tendency for the Blue Chip economists to systematically forecast more or less output growth than the FOMC. In the case of inflation forecasts, however, the Blue Chippers usually forecasted higher inflation.

Staff economists at the Federal Reserve's Board of Governors in Washington, D.C., compile the "Green Book" forecast. Prepared for FOMC members who read it advance of the meetings, it is available to the public five years later. Gavin and Mandal cited one study comparing Green Book forecasts from 1965 through 1991 that presented convincing evidence that the Green Book forecasts for inflation have been more accurate than the private forecasts, including the Blue Chip consensus from the period 1980 to 1991. In addition, they noted the study found that Green Book forecasts of inflation were better than private sector forecasts, but the evidence for output forecasts was weaker.

Gavin and Mandal concluded that as inflation became lower in the 1990's, the two forecasts converged, indicating that the private sector has gained considerable confidence in the Fed's oft-stated commitment to deliver low inflation.

"People shouldn't be surprised to learn that the Blue Chip forecasts of inflation and output closely follow that of the FOMC," Gavin and Mandal concluded. "After all, both the FOMC and the economists who contribute to the Blue Chip consensus are observing the same statistical releases and use similar economic theories to interpret the data."

Subscriptions to Review are available by calling (314) 444-8809.

With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. In addition to serving as a bank for depository institutions and the U.S. government, each Reserve Bank monitors economic conditions in the District, participates in formulating monetary policy, and supervises state-chartered member banks and bank holding companies to foster safety and soundness of the District's banking and financial institutions and to protect the credit rights of consumers.

Back to top