A snapshot of Central Bank (two year) forecasting: a mixed picture

Goodhart, C. A. E. and Pradhan, Manoj (2023) A snapshot of Central Bank (two year) forecasting: a mixed picture. CEPR Discussion Papers (DP18043). Centre for Economic Policy Research (Great Britain), London, UK.

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Abstract

Central Banks normally adjust monetary policy so that inflation hits the Inflation Target (IT) within two years. Since a central bank must believe its policy stance is appropriate to achieve this goal, its inflation forecast at the two-year horizon should generally be close to target. We examine whether this has held for three main Central Banks, Bank of England, ECB and Fed. During the IT period, there have been two crisis periods, The Great Financial Crisis (GFC), and then Covid/Ukraine. We examine how the two-year forecasts differed depending on whether we were in a crisis, or more normal, period. Although over the whole IT period, up until 2022, both forecasts and outcomes were commendably close to target, we found that this was due to a sizeable forecast underestimate of the effects of policy and inherent resilience to revive inflation after each crisis hit, largely offset by an overestimate of the effect of monetary policy to restore inflation to target during more normal times. We attribute such latter overestimation to an unwarranted belief in forward looking, ‘well anchored’, expectations amongst households and firms, and to a failure to recognise the underlying disinflationary trends, especially in 2010-2019. We outline a novel means for assessing whether these latter trends were primarily demand driven, e.g. secular stagnation, or supply shocks, a labour supply surge. Finally, we examine how forecasts for the uncertainty of outcomes and relative risk (skew) to the central forecast have developed by examining the Bank of England’s fan chart, again at the two-year horizon.

Item Type:	Monograph (Discussion Paper)
Official URL:	https://cepr.org/publications/discussion-papers
Additional Information:	© 2023 The Authors
Divisions:	Financial Markets Group
Subjects:	H Social Sciences > HG Finance H Social Sciences > HB Economic Theory
JEL classification:	D - Microeconomics > D1 - Household Behavior and Family Economics > D10 - General D - Microeconomics > D2 - Production and Organizations > D21 - Firm Behavior D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D80 - General D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D89 - Other E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E17 - Forecasting and Simulation E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level; Inflation; Deflation E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E37 - Forecasting and Simulation E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E47 - Forecasting and Simulation E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E59 - Other
Date Deposited:	19 Apr 2023 13:03
Last Modified:	14 Sep 2024 04:24
URI:	http://eprints.lse.ac.uk/id/eprint/118680

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