Jointly evaluating the Federal Reserve’s forecasts of GDP growth and inflation

In this paper we jointly evaluate the Federal Reserve staff forecasts of U.S. real output growth and the inflation rate, assuming that the forecasts are to be used as inputs for the Taylor rule. Our simple methodology generates “policy forecast errors” which have a direct interpretation for the impact of forecast errors on the target interest rate given by the Taylor rule. Without interest rate smoothing, we find that, on average, the Taylor rule target interest rate would have been approximately a full percentage point away from the intended target because of errors in forecasting output growth and inflation. Our results are robust to changes in the forecast horizon and to changes in the weights on the variables in the policy rule.