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

Goodhart, C. A. E. and Pradhan, M. (2024) A snapshot of Central Bank (two-year) forecasting: a mixed picture. Journal of Forecasting. ISSN 0277-6693

Text (Snapshot CBForecasting 25Nov24) - Accepted Version Repository staff only until 30 December 2026. Download (2MB)

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Abstract

Between 2001 and 2023, Central Bank forecasts were patently inaccurate. In this paper, we argue that many of such forecast failings were already present during the earlier years of inflation targetry. 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. Although over the IT period prior to 2020, 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 the GFC crisis hit, largely offset by an overestimate of the effect of monetary policy to restore inflation to target during the 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 recognize 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 labor 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:	Article
Additional Information:	© 2024 John Wiley & Sons Ltd.
Divisions:	Financial Markets Group
Subjects:	H Social Sciences > HG Finance
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:	06 Jan 2025 15:00
Last Modified:	15 Feb 2025 17:48
URI:	http://eprints.lse.ac.uk/id/eprint/126584

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