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Forecasting and Policy Making

By Volker Wieland and Maik H. Wolters


This chapter investigates the use of economic forecasting in policy making. Forecasts are used in many policy areas to project the consequences of particular policy measures for policymakers’ targets. After reviewing some important forecasts of fiscal authorities and central banks, we proceed to focus on the role of forecasts in monetary policy. A formal framework serves to differentiate the role of forecasts in simple feedback rules versus optimal control policies. We then provide empirical evidence that central bank policies 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 outcomes. Next, we provide a detailed exposition of methods for producing forecasts and the associated forecasting models. Practical applications with U.S. or euro area data are reported. Particular issues discussed include the use of economic structure in interpreting forecasts and the implementation of different conditioning assumptions regarding future policy that play a role in practice. We also compare the accuracy of model and expert forecasts and measure the degree of forecast heterogeneity. Finally, we utilize macroeconomic models to study the interaction of forecasting and policy by evaluating the performance and robustness of forecast versu

Topics: policy rules, expectations, business cycles, robust policy
Year: 2011
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