Monetary Policy with Judgment: Forecast Targeting

Svensson, Lars O (2005): Monetary Policy with Judgment: Forecast Targeting. Published in: International Journal of Central Banking , Vol. Volume, No. Number 1 (13 June 2005): pp. 1-54.

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 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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Inflation targeting; optimal monetary policy; forecasts
• Subjects: G - Financial Economics > G0 - General; G - Financial Economics > G0 - General > G00 - General

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