Forecast Walk-Downs and Strategic Incentives for Bias

Abstract

Are strategic incentives for bias among forecasters a necessary condition for forecast walk-downs? We identify the group of professional macro forecasters affiliated with the Federal Reserve System as a setting where forecasters are free from strategic incentives for bias. Unlike sell-side analysts, who have incentives to curry favor with management when forecasting firm-level profits, this group of professional macro forecasters faces strong incentives to produce unbiased forecasts of the U.S. economy. Remarkably, however, we document a walk-down in their GDP growth forecasts, even after excluding the corporate profit component of U.S. output. Whereas most prior explanations for forecast walk-downs are conditioned on preexisting incentives for bias, we find that asymmetrically high forecasting difficulty in downturns relative to upturns of the U.S. economy can explain the macro walk-down even in the absence of such incentives. Overall, our paper contests the traditional view of forecast walk-downs as de facto evidence of strategic incentives for bias. Time-series and cross-sectional tests further illustrate the relevance of our findings for firm-level studies. One overarching implication is that research on sell-side analysts’ forecasts should consider strategic incentives for bias alongside information about the state of the U.S. economy and heterogeneity in the cyclical exposure of individual firms to macro fluctuations.