RDP 2017-01: Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve's Approach 8. Conclusions

In this paper, we have presented estimates of past forecast uncertainty; these estimates are used by FOMC participants as a benchmark against which to assess the uncertainty of the current economic outlook. This approach, which exploits the historical forecast record of several groups, suggests that uncertainty about the economic outlook is considerable – a point emphasized by the Federal Open Market Committee in their communications on this issue. Our analysis also suggests that fan charts would be a useful communication device for the FOMC to increase public understanding about uncertainty and its policy implications.

We should repeat a caveat to our analysis: Our approach rests to a large degree on the assumption that the past is a good guide to the future and that forecasters in the future will make prediction errors similar to those made over the past twenty years. Although assumptions of this sort are a practical necessity in all empirical work, we must bear in mind that estimates of predictability have changed substantially over time. Because forecast accuracy has changed in the past, it could change again, for better or worse. If so, error-based uncertainty estimates by themselves could paint a somewhat misleading picture of the potential risks to the outlook.

For this and other reasons, error-based benchmarks of uncertainty and associated fan charts are best viewed as communication tools intended to illustrate a basic point – the future is uncertain. Attempting to go further and use this information to attempt to make explicit estimates of the likelihood of specific events is problematic, in part because the historical benchmarks alone do not provide a complete assessment of the uncertainty associated with the current outlook. It is thus important that the uncertainty benchmarks discussed in this paper and published by the FOMC are supplemented with the qualitative assessments of uncertainty provided by FOMC participants in the Summary of Economic Projections. Participants have at times assessed the outlook for both real activity and inflation as more uncertain than experienced on average in the past; they also have assessed the risks to the outlook as skewed to the downside. This additional information helps to provide a more complete sense of possible outcomes and risks than that obtained from participants' individual forecasts and the benchmark uncertainty estimates alone.