Improving Forecasts of the Federal Funds Rate in a Policy Model
John C. Robertson and Ellis W. Tallman
Federal Reserve Bank of Atlanta
Working Paper 99-3
Vector autoregression (VAR) models are widely used for policy analysis. Some authors caution, however, that the forecast errors of the federal funds rate from such a VAR are large compared to those from the federal funds futures market. From these findings, it is argued that the inaccurate federal funds rate forecasts from VARs limit their usefulness as a tool for guiding policy decisions. In this paper, we demonstrate that the poor forecast performance is largely eliminated if a Bayesian estimation technique is used instead of OLS. In particular, using two different data sets we show that the forecasts from the Bayesian VAR dominate the forecasts from OLS VAR models—even after imposing various exact exclusion restrictions on lags and levels of the data.
JEL classification: E44, C53
Key words: forecasting, Bayesian vector autoregression, federal funds rate
The author thank Jerry Dwyer and Tao Zha for helpful comments and suggestions. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to John C. Robertson or Ellis W. Tallman, Research Department, Federal Reserve Bank of Atlanta, 104 Marietta Street, NW, Atlanta, GA 30303-2713, 404/498-8782 (Robertson), firstname.lastname@example.org, 404-498-8915 (Tallman), email@example.com.