Forecast‐Based Monetary Policy: The Case of Sweden

Abstract

Central banks are dominant players in financial markets and economic policy. For both democratic and efficiency reasons, it is important that central banks' actions can be understood, predicted, and evaluated. Inflation‐targeting central banks that publish their forecasts provide unique opportunities for detailed studies of monetary policy based on real‐time data. This paper demonstrates how a central bank's forecasts can be used to identify two different forms of discretionary monetary policy: ‘policy shocks’ (deviations from systematic policy) and ‘judgements’ in forecasting.

The Role of Policy Rules in Inflation Targeting

“…The Sveriges Riksbank has a point target of 2 percent for overall CPI inflation, with a ±1 percent tolerance around that target. 17 Jansson and Vredin (2003) and Berg, Jansson, and Vredin (2002) use Riksbank forecasts in their analysis, and Huang, Margaritis, and Mayes (2001) utilize the RBNZ's published projections. For the United States, McNees (1986McNees ( , 1992 uses the Federal Reserve's internal Green Book forecasts in estimating a forward-looking reaction function, an approach that has been adopted by Orphanides (2001) and Boivin (2003), among others.…”

Forward Guidance 101A: A Roadmap of the U.S. Experience

“…The second criterion indicates not only what the projections should look like in some medium run, but also what the transition path should look like: there should be an inverse relation between the inflation gap and the output gap, with the two gaps shrinking to zero together. In order to allow visual inspection of the extent to which the projections satisfy this criterion, the Norges Bank presents a figure in which the projections for its preferred measures of inflation 13 and of the output gap are superimposed. A criterion of this kind can determine the entire forward path for policy.…”

“…Beginning with the 2007/1 issue of the Bank's Monetary Policy Report, the description of the criterion used to select the forward path of policy has been less explicit; see Qvigstad (2008) for a more recent discussion of the criteria. 13 The inflation measure emphasized by the Norges Bank in its targeting procedure, CPI-ATE, is a consumer price index that is adjusted for tax changes and energy prices.…”

“…A similar approach to inflation-forecast targeting was used for some years by Sveriges Riksbank as well (Jansson and Vredin, 2003). 3 The inflation projection continues to be presented at the front of each Inflation Report using this format, just before the summary discussion of the most recent policy decision, though it is no longer a constant-interest-rate forecast (as discussed below).…”

Inflation Targeting

“…Traditionally, inflation-targeting central banks have assumed a constant interest rate underlying its inflation forecasts, with the implication that a constant-interest-rate inflation forecast that overshoots (undershoots) the inflation target at some horizon such as two years indicates that the policy rate needs to increased (decreased) (Jansson and Vredin (2003), Vickers (1998)). Increasingly, central banks have become aware of a number of serious problems with the assumption of constant interest rates.…”