TAILIEUCHUNG - Interest Rate Forecasts: A Pathology∗

Responsibilities must be clearly assigned to individual persons and/or com- mittees. In addition, the relevant units must be functionally independent to avoid potential confl icts of interests. 20 Senior management should ensure that adequate interest rate risk management is in place for measuring, monitoring and controlling interest rate risks, and that all the relevant business units of the bank have been taken on board. Employees entrusted with interest rate risk management duties need to be aware of all types of interest rate risks across the bank, and they need to possess the necessary degree of indepen- dence vis-à-vis individuals who undertake risk positions. Senior. | Interest Rate Forecasts A Pathology Charles A. E. Goodhart and Wen Bin Lim Financial Markets Group London School of Economics This paper examines how well forecasters can predict the future time path of policy-determined short-term interest rates. Most prior work has been done using . data in this exercise we use forecasts made for New Zealand by the Reserve Bank of New Zealand RBNZ and those derived from money market yield curves in the United Kingdom. We broadly replicate recent . findings for New Zealand and the United Kingdom to show that such forecasts in New Zealand and the United Kingdom have been excellent for the immediate forthcoming quarter reasonable for the next quarter and useless thereafter. Moreover when ex post errors are assessed depending on whether interest rates have been in an upward or downward section of the cycle they are shown to have been biased and apparently inefficient. We attempt to explain those findings and examine whether the apparent ex post forecast inefficiencies may still be consistent with ex ante forecast efficiency. We conclude first that the best forecast may be a hybrid containing a specific forecast for the next six months and a no-change assumption thereafter and second that the modal forecast for interest rates and maybe for other variables as well is skewed generally underestimating the likely continuation of the current phase of the cycle. JEL Codes C53 E17 E43 E47. 1. Introduction The short-term policy interest rate has generally been adjusted in most developed countries at least during the last twenty years or so in a series of small steps in the same direction followed by a pause Author contact . Goodhart Financial Markets Group Room R414 London School of Economics Houghton Street London WC2A 2AE United Kingdom. E-mail . 135 136 International Journal of Central Banking June 2011 Figure 1. Official Cash Rate Reserve Bank of New Zealand Source Reserve Bank of New Zealand. and then a .

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