MODEL-BASED VS. PROFESSIONAL FORECASTS: IMPLICATIONS FOR MODELS WITH NOMINAL RIGIDITIES

Abstract

We compare model forecast error statistics with forecast error statistics of professional forecasts. We look at a standard sticky-prices–wages model, concluding that it delivers too strong a theoretical forecastability of the variables under scrutiny, at odds with the data (professional forecasts). We argue that the lack of compatibility between the model and professional forecasts results from trying to fit inflation (which is probably nonstationary) to a model that assumes inflation is stationary. A modified version of the model, one with a varying inflation target, delivers a better fit in terms of forecastability.