2007a), “The Case for Forecast Targeting as a Monetary Policy Strategy

A t central banks around the world, forecasts have come to play an increas-ingly important role both in policy deliberations and in communicationswith the public. The most striking examples are the Bank of England, Sweden’s Riksbank, Norway’s Norges Bank, and the Reserve Bank of New Zealand, all of which conduct policy on the basis of a procedure sometimes referred to as “inflation-forecast targeting ” (Svensson, 1997, 1999). Under this approach, the central bank constructs quantitative projections of the economy’s expected future evolution based on the way in which it intends to control short-term interest rates, and public discussion of those projections is a critical part of the way in which the bank justifies the conduct of policy to the public. What accounts for the appeal of a forecast-targeting approach, and should it be adopted more widely or more explicitly? I begin by reviewing the long-running debate between the proponents of monetary rules, intended to ensure confidence in the value of money over time, and the proponents of discretionary monetary policy, aimed at stabilizing the real economy. I will argue that inflation-forecast targeting represents a powerful synthesis of the two approaches; in particular, it is an improvement both over simpler rules, such as targeting a monetary aggregate, and over weaker versions of inflation targeting. I shall also argue that a much more extensive communication policy is crucial to escaping from the limitations of the traditional alternatives of rigid rules or rudderless discretion. I will then explore some common questions that arise about inflation-forecast targeting. Should only the inflation forecast matter, and if not, in what way should forecasts of other economic variables affect policy decisions? What assumptions about the course of future policy should be used in constructing the quantitative projections that are presented to the public? Finally, given that economic forecast