New Framework for Predicting Fed Funds Rate
In this installment, we introduce a new framework for predicting the fed funds rate two quarters ahead. By utilizing probabilities of three growth scenarios—soft-landing, stagflation, and recession—we aim to provide more accurate forecasts compared to traditional methods. This approach takes into account the dynamic nature of the post-pandemic economy, allowing for faster responses to potential risks.
Comparison of Forecasts
We compare our framework’s fed funds rate predictions with those of the Federal Open Market Committee (FOMC) and the Blue Chip consensus to determine accuracy. Over the 2012-2024 period, the Blue Chip consensus showed a higher perfect forecast accuracy rate (67%) compared to the FOMC (58%). While the FOMC had a slightly lower average forecast error (21 bps) than the Blue Chip consensus (29 bps), both missed predicting the 2019 rate cuts.
Importance of Accurate Predictions
Accurately forecasting the near-term fed funds rate is crucial for effective policymaking and communication. Central bankers, including the FOMC, use these forecasts to guide policy decisions and public communications. Our new framework aims to improve accuracy by predicting policy pivots in addition to the fed funds rate, providing decision-makers with valuable insights into the potential duration and pace of policy cycles.
As we continue to refine our toolkit and expand its applications, we hope to enhance decision-makers’ ability to navigate the complex economic landscape. By incorporating probabilities of different growth scenarios and predicting policy pivots, we aim to provide a more comprehensive and accurate forecast of the fed funds rate and its implications for the economy.
Endnotes
1 – Bernanke, Ben. “Forecasting for Monetary Policy Making and Communication at the Bank of England: A Review.” Bank of England. April 12, 2024.
2 – Hubert, Paul. (2014). “FOMC Forecasts as a Focal Point for Private Expectations.” Journal of Money, Credit and Banking, Vol 46, No 7.
3 – Clarida, R., Gali, J., and Gertler, M. (1999). “The Science of Monetary Policy: A New Keynesian Perspective.” Journal of Economic Literature, Vol XXXVII (December), pp 1661-1707.
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