Central Bank Estimates of the Unemployment Natural Rate

This paper uses real-time data and forecasts provided in historical briefing documents prepared for the Federal Open Market Committee of the United States Federal Reserve to estimate evolving central bank perceptions of the natural rate of unemployment. The briefing documents, informally known as Greenbooks, provide a unique real-time assessment of economic conditions and central bank forecasts. This paper discusses computational challenges and advantages of the Greenbook data and provides real-time estimates of the natural rate of unemployment implicit in Greenbook forecasts. Use of the Greenbook data provides several advantages over other real-time data sources. The multiperiod forecasts in a Greenbook provide repeated observations of the implicit forecast model at a given date. Importantly, Greenbook forecasts provide measures of real-time central bank perceptions that are not evident in real-time data releases. Thus, use of Greenbook forecast data provides sufficient summary measures of the ex ante information of forecasters, reduces model identification issues, and eliminates estimation biases due to unanticipated disturbances in ex post data. Despite the potential advantages, previous studies have generally limited their analysis to a subset of the Greenbook data. Some data are typically excluded because the reporting format of the dataset presents several computational challenges, including variations in the number of Greenbooks per year, differing forecast horizons per Greenbook, and the influence of judgmental add factors on near-term forecasts. An important contribution of this paper is the proposed methodology that potentially allows use of the entire data set rather than ad-hoc selections of data subsets. The paper assumes an economic structure in which the status of economic activity and the prospects for future inflation depend on how much the unemployment rate deviates from its natural rate. The structure is embedded in a time-varying parameter framework to provide improved estimates of real-time Greenbook perceptions of the natural rate of unemployment. These estimates are then used to reassess the size of central bank measurement errors of the unemployment natural rate since 1970 and interpretations of central bank forecasts and policy attributed to natural rate measurement errors.