Journal Issue

Forecasting European Central Bank monetary policy

International Monetary Fund. External Relations Dept.
Published Date:
July 2006
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Various aspects of economic behavior are known to be affected by geographic dimensions. For instance, firms in the same industry tend to cluster in geographic areas, indicating a productivity-enhancing role of proximity to other firms. The financial sector is no exception, as is evident from the existence of financial centers. Furthermore, geography plays a role in the performance of investors: local investments tend to be more profitable than remote investments. Do these findings expand into the area of monetary policy? Are there geographic heterogeneities across forecasters of monetary policy decisions? Systematic geographical differences, for instance, could arise in larger currency areas such as the United States or European Economic and Monetary Union, which encompass large and possibly quite diverse geographical regions.

A new IMF Working Paper addresses this question for the case of the European Central Bank (ECB) and finds that the accuracy of analysts’ forecasts of ECB monetary policy decisions varies considerably. In particular, there is evidence of agglomeration effects in euro area financial markets, as forecasters in financial centers outperform others. Moreover, ongoing research suggests that the ECB may not be the only central bank faced with heterogeneous expectations.

To better understand this range of forecasting results and the reasons for it, the study analyzed a novel database of monetary policy expectations by professional financial analysts from 120 institutions in 24 countries between 1999 and 2005. The database, surveyed by Reuters, found substantial differences in forecast accuracy (see chart). The top 10 percent of all institutions participating in the survey have a forecast error that is, on average, 8 basis points smaller than the error made by the worst 10 percent of performers. These differences are significant in economic terms: the best-to-worse difference of 8 basis points is about one-third the typical ECB policy rate change of 25 basis points during the sample period.

A range of expectations

The ability of analysts to accurately forecast the European Central Bank’s monetary policy decisions varies considerably.


Data: Reuters survey of 120 institutions in 24 countries between 1999 and 2005.

Explaining the variability

What explains this heterogeneity in anticipating ECB monetary policy decisions? The analysis found that geography matters for forecast accuracy. There is a surprising amount of cross-country variance in expectations about ECB policy rates—especially in the first years of the sample period. But forecast accuracy depends more on presence in a financial hub than on nationality. In fact, the best forecasters tend to be located in the financial centers of London or Frankfurt. Accuracy tends to be lower with large geographical distance from Frankfurt. In essence, agents in or near a financial hub seem to have a clear advantage over more distant observers.

Another factor driving accuracy of these forecasts is history. Analysts in countries with a history of relatively high central bank independence tend to make better forecasts of ECB behavior than others. 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.

Is the observed variation in forecasting ability systematic, rather than based on differences in “gut feeling” among analysts? The Working Paper finds that, while some systematic differences between analysts are persistent, others have been transitional and are, thus, indicative of learning.

Ongoing research by the authors indicates that these challenges may not be unique to the ECB: the U.S. Federal Reserve also faces some significant regional heterogeneity in forecasting quality among its central bank watchers. Being able to draw on a richer database for the Federal Reserve forecasts, the research suggests that the above-average performance in financial hubs is partly explained by the superior pool of economists available in these locations, suggesting that better forecasts are also at least partly related to the skills of the individual analysts.

Helge Berger, Free University of Berlin

Michael Ehrmann and Marcel Fratzscher, European Central Bank

Copies of IMF Working Paper No. 06/41, “Forecasting ECB Monetary Policy: Accuracy Is (Still) a Matter of Geography,” are available for $15.00 each from IMF Publication Services. See page 208 for ordering details. The full text is also available on the IMF’s website (

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