The FOMC, blue chip or the new framework: Predicting the Fed Funds rate – Part five

Summary

• This installment presents a new framework to predict the level of the fed funds rate two quarters out.

• We compare our framework’s fed funds forecast with the FOMC and Blue Chip forecasts to decide who is more accurate at predicting the near-term fed funds rate.

• The framework effectively predicted the turning points in the fed funds rate in the simulation analysis.

• The FOMC started providing the SEP in 2012; therefore, we employ the 2012-2024 period to identify whose fed funds rate predictions are the most accurate.

• Blue Chip has a higher perfect forecast accuracy rate (67%) than the FOMC (58%).

• The FOMC’s average forecast error is slightly lower (21 bps) than the Blue Chip consensus average error (29 bps).

• Both the FOMC's SEP and the Blue Chip consensus missed the 2019 rate cuts.

• With the September rate cut in the books and high expectations of more rate cuts in the remaining meetings of 2024, both the FOMC and the Blue Chip forecasts suffer a lower average forecast accuracy and a higher average forecast error.

• Given the historical accuracy of our approach, we believe our framework would be helpful for decision makers to improve their forecast accuracy.

• We also propose that instead of following the traditional approach of forecasting the near-term fed funds rate, forecasters should consider predicting policy pivots in addition to the fed funds rate.

Why is accurately predicting the near-term Fed Funds rate important?

This installment presents a new framework to predict the two-quarters-out level of the fed funds rate. We compare our framework’s fed funds forecast with the FOMC and Blue Chip's forecasts to examine who is more accurate at predicting the near-term fed funds rate.

Former Chairman of the Federal Reserve Ben Bernanke stated that central bankers utilize forecasts in policymaking and as policy communication tools.1 Researchers suggested that the FOMC forecasts may influence private sector forecasts.2 For example, the FOMC employs its fed funds forecast (along with its other forecasts) to communicate the near-term policy stance. In the short run, significant changes in the forecast would send undesirable signals and raise questions about the accuracy of the fed funds forecast. Therefore, in our view, accurately predicting the near-term path of the fed funds rate is vital for effective policymaking as well as policy communications.

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