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January 31, 2007
Central Bank Forecasting
Sweden’s Riksbank, the world’s oldest central bank, has just joined a small group of institutions with a no-nonsense solution: policymakers publish a forecast of where they expect to set interest rates in the future. This is not as radical as it sounds. If they are competent, they should have a view. And it forms another step towards transparency. Europe’s central banks once made inflation forecasts on the assumption of constant interest rates – a pretty silly premise. Now the European Central Bank and BoE [Bank of England] assume a more realistic market yield curve. But they expend an inordinate amount of energy hinting at how plausible they believe that curve is. Far better just to say, explicitly, what they think.
Seems sensible, though the article contains a picture that does sort of suggest that such forecasts may not be all that useful:
I shouldn't push too hard on that picture because it really doesn't prove anything beyond the obvious point that forecasting is tough business. If a central bank's policy responses to its forecasts are consistent, there is plenty of information conveyed by those forecasts, even if they prove to be wildly off-base after the fact.
But I do have to object to the claim that an inflation forecast made "on the assumption of constant interest rates " is "a pretty silly premise." One might argue that the most sensible approach to policymaking is to take each meeting as it comes, without assuming too much about the shape of future policy to come. In other words, assume no change in policy, check out the forecasted path of inflation and whatever else you care about, and change things if the forecast deviates from the direction you hope things will go. Show up at the next meeting and repeat.
This has the benefit of pretty clearly revealing the central bank's objectives without emphasizing the path that will be taken to reach those objectives. And if you are wondering why a policymaker might want to emphasize the ends rather than the means, see the picture above.
You could still convince me that the assumption of a constant interest rate isn't the best way to go -- perhaps because information about how the central bank views the likely path of future policy really does help anchor expectations, for example. But silly? I'm thinking not.
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