RDP 2016-02: Disagreement about Inflation Expectations 7. Is Disagreement a Proxy for Forecast Uncertainty?

Despite conceptual differences, disagreement among forecasters is often used as a proxy for mean forecast uncertainty (Bloom 2014). In theory, an increase in disagreement can occur when there is no change in uncertainty – if at least some agents change their reported expectation, but all are no less sure about the likely outcome – but in practice forecaster disagreement co-moves with other measures of economic uncertainty (e.g. mentions of economic uncertainty in newspapers).

In this section, we investigate whether disagreement in inflation expectations is related to the magnitude of RBA inflation forecast errors. We assess predictability of the magnitude of RBA forecast errors, rather than the forecast errors in the mean expectation of each survey measure, because these forecasts are of most interest for the setting of monetary policy.

Figure 14 shows a scatterplot of absolute RBA year-ahead CPI inflation forecast errors against disagreement in CPI inflation expectations. For the Consensus Economics and RBA survey measures, there is some evidence that large forecast errors were preceded by a relatively high level of disagreement among survey respondents.

We formally test for a relationship between forecast disagreement and the magnitude of RBA CPI inflation forecast errors by estimating the following regression for each inflation survey measure:

where π_{t + h} is CPI inflation over the period t to t + h, π_{t + h|t} is the time t RBA forecast, and thus is the magnitude of the RBA's inflation forecast error. We use the standard deviation of year-ahead inflation forecasts for each survey measure i as our measure of disagreement: σ_{t:t + 4}. The absolute value of past forecast errors, , are included as a control variable.

Consistent with the graphical evidence, the estimated β parameters are positive for the Consensus Economics and RBA survey measures, suggesting some positive relationship between forecast disagreement and the magnitude of RBA forecast errors, but the relationship is not precisely estimated. There is no evidence of a relationship between disagreement and forecast errors for the union and consumer survey measures. Taken together, the regression results reported in Table 9 provide relatively weak evidence that forecast disagreement can be used to predict the magnitude of RBA inflation forecast errors.