Monetary policy credibility, avoiding dark corners, and risk management: a response to Ben Bernanke's review of monetary policy-making at the Bank of England

Ben Bernanke's Forecasting for Monetary Policy Making and Communication at the Bank of England: A Review (Bernanke, 2024) provides a stimulus for central banks worldwide to rethink their approach to monetary policy-making. In this paper we present an analytical framework which is designed to guide this re-evaluation. We agree with Bernanke that central banks need to adopt a scenario-based approach to monetary policy. And we also agree that there is the need for policy-makers to make clear how their policy is likely to respond to whatever scenario is being considered within the policy discussion. But—in addition—we emphasize the need to build a strategy to maintain credibility of monetary policy. In particular, we present the Forecasting and Policy Analysis System (FPAS), a scenario-based approach which has been adopted by the central banks of Armenia and Georgia. We show how using such a system can help policy-makers avoid ‘dark corners’—conditions where inflation destabilizes monetary goals. This FPAS system integrates Alan Greenspan's principles of risk management with a transparent and accountable structure. A cornerstone of this system is the Endogenous Policy Credibility (ENDOCRED) model, a multi-country gap model. This model focuses on key nonlinearities that capture how monetary policy credibility might be gained, or lost, through policy action. We describe the application of the ENDOCRED model to the US and euro area during the Covid pandemic. The ENDOCRED model's insights highlight the critical interplay between credibility, risk management, and macroeconomic stability in crafting an effective monetary policy framework.