Fed Watching - A question of Accuracy

Apart from my continuing rant about how the ECB does not know what it is doing raising rates into 2007 the Central Bank's research department is churning out reasearch papers covering many different topics at a staggering pace.  One of the recent and more interesting ones is this one about the accuracy of Fed watchers. And as the authors say in their review of the existing literature on the topic:

To the best of our knowledge, our focus on explaining the cross-section heterogeneity in monetary policy expectations for the Fed’s FOMC is new. It is related to two well-established strands in the trade and finance literature looking at the role of information and geography, as well as to the emerging literature on central bank communication.

So what do we have here?

Well, I am cruising into uncharted waters here but given the author's reference to 'already existing' literature on related matters an initial outline shows that information and geography plays a distinctive part in the performance of financial market analysts but also generally in terms of determining asset prices and trading behavior; ok this sounds reasonable. The paper then more accurately sets out to test the scope of the influence of information and geography;

The present paper analyzes whether this role of information and geography extends to the way financial market participants anticipate US monetary policy. In particular, we ask to what extent geography, regional economic developments, and personal skills determine the ability of professional forecasters to predict monetary policy decisions by the US Federal Reserve.

The emipirical foundation is also worth noting I think ...

The paper uses a novel dataset of 268 professional forecasters who are located across 98 cities in 15 countries, for FOMC decisions between February 1999 and September 2005.

So what about the conclusions then? Well first and foremost the paper outlines the heterogenous nature of the forecasters' accuracy and furthermore how this affects trading behavior and market volatility.

The paper has demonstrated that this heterogeneity has important repercussions on trading behavior, with significant effects on market volatility. This could distort investment decisions of firms, make it more difficult for firms to raise funds for investment or production, and could decrease the efficient allocation of capital. But what explains the heterogeneity in forecasting accuracy? The paper has focused on the role of geography and skills of analysts in forecasting US
monetary policy.

So on Geography:

We show that a number of locational factors systematically influence the ability of forecasters toanticipate US monetary policy. In particular, the prediction error of those in Washington DC, New York City or in another financial center, either in the USA or abroad, is about 2 to 4 b.p. lower.

And skills:

As to the role of skills, a revealing point of the empirical analysis is that forecasters that are good in forecasting inflation also perform well in predicting monetary policy decisions. This provides a strong, and the most direct piece of evidence that skills and individual background are significantly linked to the forecast accuracy of monetary policy decisions.

Oh and of course since we actually need to come away with something for the boss ... policy implications.

What do these findings imply for policy? First of all, it should be stressed that not all heterogeneity in expectations is necessarily undesirable from a policy perspective, in particular if such differences are the result of different degrees of investment in information gathering by analysts’ institutions. Moreover, differential expectations about policy decisions may at times also provide useful information to policy-makers. Therefore, the primary nature of the analysis of
the paper is a positive one, i.e. to document the magnitude and understand the determinants of the heterogeneity in monetary policy expectations.

So if anyone ever aks you at dinner party about the heterogenous nature of monetary policy expectations in the US you now know what to answer.