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Monetary Policy with Judgment: Forecast Targeting

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  • Svensson, Lars O
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.

Suggested Citation

  • Svensson, Lars O, 2005. "Monetary Policy with Judgment: Forecast Targeting," MPRA Paper 819, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:819
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Inflation targeting; optimal monetary policy; forecasts;
    All these keywords.

    JEL classification:

    • G0 - Financial Economics - - General
    • G00 - Financial Economics - - General - - - General

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