Forecasting Performance and Influence of Communicating Central Banks - PDF document

Forecasting Performance and Influence of Communicating Central Banks Paul Hubert * SciencesPo - OFCE November 2009 Abstract This paper focuses on five central banks, which communicate their forecasts in real-time and for which information asymmetry should therefore be minimized, to assess whether the central bank has a better forecasting performance than private agents. Results challenge the findings of the seminal paper by Romer and Romer (2000), in which they evidence the informational advantage of the Fed, a central bank which publishes its forecasts with a 5- year lag. One out of five communicating central banks, the Swedish one, has a robust superior forecasting performance, which reveals a paradox as information is supposed to be symmetric since central banks’ forecasts are available to private agents. It appears that the Riksbank benefits from a specific competence in gathering new private information between each forecast’s release. Furthermore, since forecasts are published in real-time, this paper is able to assess whether central banks influence private agents. It is shown that three out of five central banks have influential power on private agents through forecasts’ publication. This paper shows central banks need not be more competent or informed to be influential, and then proposes to distinguish endogenous credibility due to informational advantage from exogenous credibility. Keywords: Monetary Policy, Forecasts, Influence, Imperfect Information, Communication. JEL Classification: E52, E58 * I thank Jean Boivin, Jérôme Creel, Jean-Paul Fitoussi, Petra Geraats, Charles Goodhart and Nicolas Petrosky- Nadeau for helpful comments. This research has benefitted from presentations at the 2009 EEA Conference (Barcelona), OFCE, the 26th International Symposium on Money, Banking and Finance (Orléans), and the Louvain School of Management’s conference ‘New Challenges to Central Banking’ (Namur). All errors remain mine. Contact: paul.hubert@ofce.sciences-po.fr. SciencesPo – OFCE, 69 quai d’Orsay, 75340 Paris Cedex 07. 1

1. Introduction In the last decades, there has been a strong interest in transparency and information issues in monetary policy emphasizing the role of expectations in policy outcomes. The expectations channel of monetary policy has indeed taken a more and more important place in the most recent monetary policy models which consider central banking as management of expectations. Do central banks have superior forecasting performance and private information? Are central banks able to convey information to private agents? Can central banks influence private agents’ expectations? Is greater transparency sufficient to influence them? These issues are essential because they contribute to assess the importance of one of the most uncertain and subtle channel of monetary policy. Many authors, following the seminal work of Romer and Romer (2000), have assessed in the US the relative forecasting performance of the private sector and the Federal Reserve, a central bank which publishes 1 its forecasts after five years, and thus benefits from an informational advantage. However, this has not been extended to communicating central banks. Yet, by looking at the relative forecasting performance of some more transparent central banks that publish their forecasts more quickly, different hypotheses may be sorted out: the importance of relative information sets or of information processing capacities, for instance. It also provides a way to analyse the question of influence and credibility. If private agents know the current central bank forecast and that central bank forecasts are superior but still has a different one, that might be more directly related to credibility than in a situation where private agents do not know the central bank forecast. Focusing on a set of communicating central banks thus allows emphasizing the expectations channel. The first contribution of this paper is to test empirically whether central banks publishing their forecasts in real-time, a situation in which information is communicated and thus supposed to be symmetric, have a better forecasting performance than private agents. From this analysis, I investigate possible sources of forecasting performance and depart from a sole focus on the Fed through comparisons between diverse communication strategies, interest rate scenarios for forecasting, and central bank frameworks, and assess whether better forecasting performance is compatible with forecasts’ communication or depends on low transparency. In other words, I test the hypothesis that greater transparency really reduces or prevents superior forecasting performance. Furthermore, I deduce in parallel whether communication of information tends to improve private agents’ ability to forecast. According to the pioneering work of Morris and Shin (2002, 2005), more transparency is not always beneficial, while implications of release of information are positive for Woodford (2005), Svensson (2006) and Gosselin, Lotz and Wyplosz (2008), and negative according to Amador and Weill (2008). This debate has led Cecchetti and Hakkio (2009) to study whether greater transparency has impacted dispersion of private agents forecasts. In this paper I assess whether greater transparency has an effect on private agents forecast errors. 1 It may be argued that the Fed is not a less transparent central bank as it releases its policymaker (FOMC) forecasts twice a year with a three week lag, besides its statements and minutes. However, Gavin and Mandall (2001) and Romer and Romer (2008) have shown that those forecasts do not contain useful information. In other words, they show that the Fed releases its forecasts which are not informative (the FOMC ones) while publishes after a 5-year embargo those with useful information content (the Greenbook ones). The Fed is therefore transparent for some points (actions, justification of these actions for instance) and is less transparent for some other points (its forecasts) and the 5-year embargo confirms that the Greenbook forecasts have some value added. In the end, analysing whether this relative opacity is good or not is beyond the scope of this work. However, as this paper focuses on forecasts, its standpoint is to consider as a reasonable statement that the Fed is less transparent concerning its informative (cf. Romer and Romer (2000, 2008)) projections. 2