Geography matters if you are forecasting ECB rates, according to new IMF Working Paper 06/41 by Helge Berger of the Free University Berlin and ECB economists Michael Ehrmann and Marcel Fratzscher.
The authors looked at Reuters surveys of ECB rate forecasts from 120 institutions in 24 countries between 1999 and 2005. Their paper, Forecasting ECB Monetary Policy: Accuracy Is (Still) a Matter of Geography, found "substantial" differences in forecast accuracy.
They concluded that London and Frankfurt-based forecasters were more accurate than the rest, and that "accuracy tends to be lower with greater geographical distance to Frankfurt." (Frankurt am Main is home both to the ECB and the Deutsche Bundesbank). But there are also other factors at work:
A second finding is that national macroeconomic conditions also tend to influence forecast accuracy, as the predictions of ECB policies become less precise if the forecaster is located in a country where inflation or unemployment rates deviate from the euro area average.
A third factor driving accuracy seems to be history. Analysts working for institutions reporting predominantly from countries with a history of relatively high central bank independence tend to make better forecasts of ECB behavior.
Finally, we show that the observed heterogeneity is systematic rather than based on differences in “gut feeling” among analysts. ...While some of the systematic differences between analysts have been transitional and are thus indicative of learning, other asymmetries in forecasting performance are more persistent.
The authors find "a broadly similar and stable pattern of forecast accuracy across countries and institions" for both the expected level of ECB rates, and the timing of rate adjustments.
They contend that "geographic proximity and common sociocultural attitudes remain key" when it
comes to information spillovers and processing. So what are the policy implications of this hetereogeneity?
Our results have important policy implications. Expectations are a crucial factor in the transmission of monetary policy. And a central bank operating in a heterogeneous environment such as the ECB needs to be aware of differences in the ability of economic agents to understand and anticipate monetary policy—differences that appear to be significant in the case of the euro area.
To a small degree, this heterogeneity is transitory and therefore not a cause of great concern. However, a substantial part of it appears to persist. Euro area financial markets have yet to converge on a homogeneous view of the ECB, to overcome locational and national biases, and to adopt a common expectation-formation process.
Although some informational frictions and asymmetries or agglomeration effects may be a permanent feature of financial activity in any region, there seems to be scope for continuous guidance of this convergence process by a careful and targeted communication policy by the central bank.
Persistent heterogeneity helps explain why the ECB is less successful in getting across a unified messages to financial markets than the Federal Reserve or Bank of England. Financial analysts across Europe have different monetary policy expectations and use varied Taylor rules, so are unlikely to interpret such messages consistently.
Second, key players within the ECB - coming from different policy environments - can also be expected to have differing views of the appropriate policy stance. Such a divergence of views presents quite a challenge for any ECB President. The temptation must surely be to gag other Governing Council members!
I'd appreciate some guidance on this, because I'm not an economist.
My understanding is that the ECB's primary objective is price stability, or at least that's what its statute says. The statute also doesn't mention anything about 'unemployment' or 'growth', so far as I can see, so the mandate is not comparable to say, the Fed's: the ECB are technocrat inflation-fighters.
So why the speculation about rates?
Isn't it almost a foregone conclusion what they're going to do?
(It always has been for me, at least since the €uro was introduced)
So why do informed people like yourself treat it as a mystery, NE?
Posted by: hirvi | Tuesday, February 21, 2006 at 05:42 PM