Bringing NGDP expectations into the picture

In a recent post Evan Soltas wrote:

I recently discovered that the Survey of Professional Forecasters has been recording NGDP expectations since 1968. Better yet for those inclined — that is, me — they have all of the individual anonymized forecast records, mean forecasts, median forecasts, and cross-sectional dispersion statistics on the forecasts. And it’s a quarterly forecast for several quarters ahead.

You can do a lot with this. I’ve actually never seen someone really work with Survey numbers to make the NGDP case, and this is only the tip of the iceberg. (I’m practically pleading with everyone else to write something.)

In this post I´ll take a preliminary stab at it. The first chart depicts actual NGDP growth (%YoY) and the expected (with expectations being made in quarter t-1) NGDP growth for the same quarter.


Up to 1997 everything is progressing fine, with little divergence between expected and realized growth. In 1998/99 the Fed, by words and deeds following the Asia/Russia crisis, LTCM, etc., induced NGDP growth expectations to “shoot-up”. The Fed reacts and both realized and expected NGDP growth tumble.

After 2002, mostly by words (given interest rates had been lowered to 1%) – forward guidance – the Fed/FOMC not only stabilized expectations of NGDP growth but indicated that it wanted to get the economy back to the “Great Moderation” trend level path, in which case NGDP growth and growth expectations had to be higher than the 5.5% trend growth for a period.

The following chart shows that this in fact happened, with NGDP reaching the ‘desired’ trend by early 2006, at the time Greenspan said ‘good-bye’. Soon, however, worried about oil and commodity price, Bernanke´s FOMC let NGDP growth fall below the trend path. Expectations of NGDP growth turned lower, and even slightly negative, but no one could “imagine”, given it had never been experienced in the post WW2 period, that NGDP growth could fall so much.


And the recovery has been sluggish because, although NGDP growth and growth expectations have turned positive (and expectational errors strongly reduced), they are far from enough to close (even part) of the gap that opened up after mid-2008.

Update: JP Irving is doing interesting (hopefully promising) research on the topic of gauging NGDP expectations:

I think I’m closing in on a way to capture the market’s underlying NGDP forecast.

Here is what I propose, as a start:

Take daily time series data, closing prices, on 5-year U.S. government bonds, 5 year TIPS spreads, the broad trade-weighted dollar index, the S&P500, WTI front month contract prices and LME front month copper prices.

We should all agree that an ‘exogenous’ change in the market NGDP forecast, will yield a change in all of these market prices. Say, something like the Fed cutting rates more or less than expected, ditto QE. If you don’t believe that, then either you are allowing your ego-investment in decades of New Keynesian thinking to cloud your judgement, or you haven’t read Nunes and Cole’s new book. (I haven’t either, but I will and can only assume the content would lead one to this understanding)

So my idea is to take the first principal component of these time series, and treat it as in some way proportional to future NGDP. Lars did something similar a few months back. The resulting component wouldn’t be interpretable as an NGDP forecast, but we could aggregate it to quarterly frequency and use it to drive an NGDP forecast equation. We would need many equations actually, to find the “NGDP expectations curve” (which would be like this inflation curve) and in turn find the expected NGDP path. I deliberately included only 5 year bond yields, to weight the factor on 5 year NGDP expectations, though maybe 2 or 3 year rates would be better.

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