Federal Reserve vs. consumer forecasts of inflation: 1979–1983

Abstract

This article tests the asymmetric information hypothesis using the CPI inflation forecasts of the Federal Reserve and consumers for the volatile inflationary period of 1979–1983. The Fed generally over-predicted inflation, but consumers produced unbiased forecasts with superior predictive content. In fighting inflation, the Fed was, perhaps, cautious by assigning much cost to under-predictions, but little or no cost to over-predictions. Under such an asymmetric loss function, the bias in the Federal Reserve forecast of inflation appears to be rational. However, this explanation, while plausible, cannot be substantiated from the Federal Open Market Committee (FOMC) transcripts.

Acknowledgement

Sadly, Mohamed Soliman passed away before this publication of this article. His contributions to economics and AVS will be missed.

Notes

¹ Comparing the SRC data with the inflation forecasts from various surveys of economists, Gramlich (1983) and Thomas (1999) conclude that consumers generally forecast inflation better than the presumably informed economists.

² For a counterfactual experiment of a strongly inflation averse Federal Reserve and its implications for inflation during 1979–1983, see Söderlind (2004).

³ The SRC data are available at http://www.sca.isr.umich.edu/data-archive/mine.php.

⁴ For more information on the methodological issues, see Batchelor (2001, pp. 232–233).

⁵ For some empirical evidence in support of the ‘economically’ rational expectations hypothesis, see Baghestani (1992) and Mitra and Rashid (1996).