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Inflation Targeting: to Forecast or to Simulate

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  • Michal Skorepa

    (Czech National Bank)

  • Viktor Kotlan

    (Czech National Bank)

Abstract

Inflation targeting is a regime based to a great extent on communication and, more specifically, on using and communicating assessments of future inflation. The central banking literature, however, devotes surprisingly little attention to some important issues connected with such assessments. There are some non-trivial choices that need to be made regarding future inflation assessments on three distinct levels: construction, decision making and communication. One of the most important choices relates to the treatment of the central bank’s behaviour within the assessment. We first differentiate between two basic ways of assessing future inflation: forecast and simulation. A forecast is the most likely picture of the future. In a forecast, all agents are assumed to behave in the most likely way. A simulation, on the other hand, is the most likely picture of the future if the behaviour of one agent follows a predetermined path or is generated using a selected reaction function. The path or reaction function ascribed to the agent does not have to be the most likely one. After differentiating between a forecast and a simulation, we discuss the pros and cons of using the two ways of assessing future inflation on the three abovementioned levels.

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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0304007.

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Length: 19 pages
Date of creation: 16 Apr 2003
Date of revision:
Handle: RePEc:wpa:wuwpma:0304007

Note: Type of Document - ; pages: 19. CNB Internal Research and Policy Note 1/03
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Web page: http://128.118.178.162

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Keywords: inflation targeting; forecast; simulation; central bank; decision making; communication;

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References

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  1. Eric M. Leeper & Tao Zha, 1999. "Modest policy interventions," Working Paper 99-22, Federal Reserve Bank of Atlanta.
  2. Leitemo, Kai, 2003. " Targeting Inflation by Constant-Interest-Rate Forecasts," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 609-26, August.
  3. Charles A.E. Goodhart, 2001. "Monetary transmission lags and the formulation of the policy decision on interest rates," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 165-186.
  4. Stephen Morris & Hyun Song Shin & Hui Tong, 2006. "Social Value of Public Information: Morris and Shin (2002) Is Actually Pro-Transparency, Not Con: Reply," American Economic Review, American Economic Association, vol. 96(1), pages 453-455, March.
  5. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
  6. Jeffrey D. Amado & Stephen Morris & Hyun Song Shin, 2003. "Communication and Monetary Policy," Cowles Foundation Discussion Papers 1405, Cowles Foundation for Research in Economics, Yale University.
  7. Sharon McCaw & Satish Ranchhod, 2002. "The Reserve Bank's forecasting performance," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 65, December.
  8. Tim Hampton, 2002. "The role of the Reserve Bank's macro model in the formation of interest rate projections," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 65, June.
  9. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
  10. Hossein Samiei & Jan Kees Martijn, 1999. "Central Bank Independence and the Conduct of Monetary Policy in the United Kingdom," IMF Working Papers 99/170, International Monetary Fund.
  11. Lars E. O. Svensson, 2006. "Social Value of Public Information: Comment: Morris and Shin (2002) Is Actually Pro-Transparency, Not Con," American Economic Review, American Economic Association, vol. 96(1), pages 448-452, March.
  12. Frederic S Mishkin, 2004. "Can Central Bank Transparency Go Too Far?," RBA Annual Conference Volume, in: Christopher Kent & Simon Guttmann (ed.), The Future of Inflation Targeting Reserve Bank of Australia.
  13. Michal Skorepa & Viktor Kotlan, 2003. "Inflation Targeting: to Forecast or to Simulate," Macroeconomics 0304007, EconWPA.
  14. Professor Lars E O Svensson, 2001. "Independent review of the operation of monetary policy in New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 64, March.
  15. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
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Cited by:
  1. Viktor Kotlan & David Navratil, 2003. "Inflation Targeting as a Stabilisation Tool: Its Design and Performance in the Czech Republic," Macroeconomics 0310006, EconWPA.
  2. Michal Skořepa & Viktor Kotlán, 2006. "Inflation Targeting: To Forecast or To Simulate?," Prague Economic Papers, University of Economics, Prague, vol. 2006(4), pages 300-314.
  3. David Navrátil & Viktor Kotlán, 2005. "Is the CNB Predictable?," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 55(7-8), pages 333-343, July.

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