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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)

Abstract

We analyse the panel of the Greenbook forecasts (sample 1970-1996) and a
large panel of monthly variables for the US (sample 1970-2003) and show that
the bulk of dynamics of both the variables and their forecasts is explained by two
shocks. Moreover, a two factor model which exploits, in real time, information
on many time series to extract a two dimensional signal, produces a degree of
forecasting 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 us
to conclude that the stochastic dimension of the US economy is two. We also show
that dimension two is generated by a real and nominal shock, with output mainly
driven by the real shock and inflation by the nominal shock. The implication is
that, by tracking any forecastable measure of real activity and price dynamics, the
Central Bank can track all fundamental dynamics in the economy.

JEL subject classification : E52, E58, C33, C53

Keywords and phrases : Taylor rules, real time analysis, monetary policy, forecasting,
large datasets 

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Last updated February 27, 2007