Monetary Policy with Judgement: Forecast Targeting

Lars E.O. Svensson ()

No 5072, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: ‘Forecast targeting’, forward-looking monetary policy that uses central-bank judgment to construct optimal policy projections of the target variables and the instrument rate, may perform substantially better than monetary policy that disregards judgment and follows a given instrument rule. This is demonstrated in a few examples for two empirical models of the US economy, one forward looking and one backward looking. A complicated infinite-horizon central bank projection model of the economy can be closely approximated by a simple finite system of linear equations, which is easily solved for the optimal policy projections. Optimal policy projections corresponding to the optimal policy under commitment in a timeless perspective can easily be constructed. The whole projection path of the instrument rate is more important than the current instrument setting. The resulting reduced-form reaction function for the current instrument rate is a very complex function of all inputs in the monetary-policy decision process, including the central bank’s judgment. It cannot be summarized as a simple reaction function such as a Taylor rule. Fortunately, it need not be made explicit.

Keywords: forecasts; inflation targeting; optimal monetary policy (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2005-05
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Related works:
Working Paper: Monetary Policy with Judgment: Forecast Targeting (2005)
Working Paper: Monetary Policy with Judgment: Forecast Targeting (2005)
Working Paper: Monetary policy with judgment - forecast targeting (2005)
Journal Article: Monetary Policy with Judgment: Forecast Targeting (2005)
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