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Are model-based inflation forecasts used in monetary policymaking? A case study

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Author Info
Stefano Siviero () (Bank of Italy, Economic Research Department)
Daniele Terlizzese () (Bank of Italy, Economic Research Department)
Ignazio Visco () (Bank of Italy, Economic Research Department)

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Abstract

The process through which economic policy is conceived and decided cannot be simply described as the optimisation of a well-defined loss function subject to the constraints provided by a model of the economy. Even ignoring the forbidding difficulties of eliciting a stable and explicit loss function from real-life policymakers, the availability of a model reliably describing all the responses of a complex economy to policy interventions is hardly to be expected. Policy will therefore be made against the background of an incomplete model, lacking some policy transmission channels, subject to data revision and possibly to instability in the estimated equations, requiring continuous reassessment in the light of the available data. Drawing on the experience gained with a macroeconometric model at the Bank of Italy, in this paper we describe the uses to which such a model can be put in the policymaking process. We find empirical support for the claim that the model is used in policymaking by assessing the extent to which the monetary policy followed by the Bank of Italy in a recent episode was influenced by inflation projections that diverged from the announced targets and by trying to identify other influences that played a role. The episode considered covers the 1995-97 disinflation, when upper limits to the current- and next-year inflation rates were explicitly announced by the Governor. The empirical analysis clearly indicates a role for model forecasts of inflation in monetary policymaking. This conclusion is robust, as inflation forecasts are shown to possess explanatory power with respect to policy choices, together with a number of other factors, including lagged values of the policy instrument, lagged inflation and other, independent, inflation forecasts.

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Paper provided by Bank of Italy, Economic Research Department in its series Temi di discussione (Economic working papers) with number 357.

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Date of creation: Sep 1999
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Handle: RePEc:bdi:wptemi:td_357_99

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Keywords: Forecasting; policymaking;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  2. Altissimo, F. & Siviero, S. & Terlizzese, D., 1999. "How Deep Are the Deep Parameters?," Papers 354, Banca Italia - Servizio di Studi.
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  3. Altissimo, F. & Violante, G.L., 1998. "Nonlinear VAR: Some Theory and an Application to the US GNP and Unemployment," Papers 338, Banca Italia - Servizio di Studi.
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  11. Gressani, Daniela & Guiso, Luigi & Visco, Ignazio, 1988. "Disinflation in Italy: An analysis with the econometric model of the bank of Italy," Journal of Policy Modeling, Elsevier, vol. 10(2), pages 163-203. [Downloadable!] (restricted)
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  15. Gambacorta, L., 1999. "What Is the Optimal Institutional Arrangement for a Monetary Union?," Papers 356, Banca Italia - Servizio di Studi.
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  18. Gaiotti, E. & Gavosto, A. & Grande, G., 1997. "Inflation and Monetary Policy in Italy: Some Recent Evidence," Papers 310, Banca Italia - Servizio di Studi.
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Filippo Altissimo & Eugenio Gaiotti & Alberto Locarno, 2002. "Is money informative? Evidence form a large model used for policy analysis," Temi di discussione (Economic working papers) 445, Bank of Italy, Economic Research Department. [Downloadable!]
    Other versions:
  2. Dario Focarelli & Alberto Franco Pozzolo, 2000. "The Determinants of Cross-Border Bank Shareholdings; an Analysis with Bank-Level Data from OECD Countries," Temi di discussione (Economic working papers) 381, Bank of Italy, Economic Research Department. [Downloadable!]
    Other versions:
  3. Stefano Siviero & Daniele Terlizzese, 2001. "Macroeconomic forecasting: Debunking a few old wives' tales," Temi di discussione (Economic working papers) 395, Bank of Italy, Economic Research Department. [Downloadable!]
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