Working Paper Abstract
284."Monetary Policy in Real Time"by Domenico Giannone (ECARES, UniversitÚ Libre de Bruxelles), Lucrezia Reichlin (ECARES, UniversitÚ Libre de Bruxelles and CEPR) and Luca Sala (IGIER and IEP, UniversitÓ Bocconi)
We analyse the panel of the Greenbook forecasts (sample 1970-1996) and alarge panel of monthly variables for the US (sample 1970-2003) and show thatthe bulk of dynamics of both the variables and their forecasts is explained by twoshocks. Moreover, a two factor model which exploits, in real time, informationon many time series to extract a two dimensional signal, produces a degree offorecasting accuracy of the federal funds rate similar to that of the markets, and,for output and inflation, similar to that of the Greenbook forecasts. This leads usto conclude that the stochastic dimension of the US economy is two. We also showthat dimension two is generated by a real and nominal shock, with output mainlydriven by the real shock and inflation by the nominal shock. The implication isthat, by tracking any forecastable measure of real activity and price dynamics, theCentral Bank can track all fundamental dynamics in the economy.
JEL subject classification : E52, E58, C33, C53Keywords and phrases : Taylor rules, real time analysis, monetary policy, forecasting,large datasets
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