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Monetary Policy with Judgment: Forecast Targeting

Lars Svensson

No 11167, NBER Working Papers from National Bureau of Economic Research, Inc

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 U.S. 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 complicated 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.

JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
Date: 2005-03
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Note: ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (115)

Published as Lars E O Svensson, 2005. "Monetary Policy with Judgment: Forecast Targeting," International Journal of Central Banking, International Journal of Central Banking, vol. 1(1), May.

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