IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/819.html
   My bibliography  Save this paper

Monetary Policy with Judgment: Forecast Targeting

Author

Listed:
  • 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
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/819/1/MPRA_paper_819.pdf
    File Function: original version
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Lars E.O. Svensson & Robert J. Tetlow, 2005. "Optimal Policy Projections," International Journal of Central Banking, International Journal of Central Banking, vol. 1(3), December.
    2. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711.
    3. Sharon Kozicki, 1999. "How useful are Taylor rules for monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, vol. 84(Q II), pages 5-33.
    4. Albert Marcet & Ramon Marimon, 2019. "Recursive Contracts," Econometrica, Econometric Society, vol. 87(5), pages 1589-1631, September.
    5. Noah Williams & Lars E.O. Svensson, 2005. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," Computing in Economics and Finance 2005 108, Society for Computational Economics.
    6. Christopher A. Sims, 2002. "The Role of Models and Probabilities in the Monetary Policy Process," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 1-62.
    7. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June.
    8. Currie,David & Levine,Paul, 2009. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521104609, October.
    9. Bennett T. McCallum & Edward Nelson, 2005. "Targeting versus instrument rules for monetary policy," Review, Federal Reserve Bank of St. Louis, vol. 87(Sep), pages 597-612.
    10. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    11. Jon Faust & Dale W. Henderson, 2004. "Is inflation targeting best-practice monetary policy?," Review, Federal Reserve Bank of St. Louis, vol. 86(Jul), pages 117-144.
    12. Svensson, Lars E. O. & Woodford, Michael, 2003. "Indicator variables for optimal policy," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 691-720, April.
    13. Bennett T. McCallum & Edward Nelson, 2005. "Targeting versus instrument rules for monetary policy," Review, Federal Reserve Bank of St. Louis, vol. 87(Sep), pages 597-612.
    14. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters, in: Monetary Policy Rules, pages 203-262, National Bureau of Economic Research, Inc.
    15. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-1311, July.
    16. Rudebusch, Glenn D, 1992. "Trends and Random Walks in Macroeconomic Time Series: A Re-examination," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 33(3), pages 661-680, August.
    17. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
    18. Reifschneider, David L. & Stockton, David J. & Wilcox, David W., 1997. "Econometric models and the monetary policy process," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 1-37, December.
    19. Lars E.O. Svensson & Kjetil Houg & Haakon O.Aa. Solheim & Erling Steigum, 2002. "An Independent Review of Monetary Policy and Institutions in Norway," Working Papers 120, Princeton University, Department of Economics, Center for Economic Policy Studies..
    20. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April.
    21. Klein, Paul, 2000. "Using the generalized Schur form to solve a multivariate linear rational expectations model," Journal of Economic Dynamics and Control, Elsevier, vol. 24(10), pages 1405-1423, September.
    22. Lars E.O. Svensson, 2004. "Targeting Rules vs. Instrument Rules for Monetary Policy: What is Wrong with McCallum and Nelson?," NBER Working Papers 10747, National Bureau of Economic Research, Inc.
    23. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May.
    24. repec:pri:cepsud:82svensson is not listed on IDEAS
    25. Backus, David & Driffill, John, 1986. "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," CEPR Discussion Papers 124, C.E.P.R. Discussion Papers.
    26. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
    27. Linde, Jesper, 2005. "Estimating New-Keynesian Phillips curves: A full information maximum likelihood approach," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1135-1149, September.
    28. Petra M. Geraats, 2002. "Central Bank Transparency," Economic Journal, Royal Economic Society, vol. 112(483), pages 532-565, November.
    29. Walsh, Carl E, 2004. "Robustly Optimal Instrument Rules and Robust Control: An Equivalence Result," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(6), pages 1105-1113, December.
    30. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
    31. Lars E.O. Svensson & Kjetil Houg & Haakon O.Aa. Solheim & Erling Steigum, 2002. "An Independent Review of Monetary Policy and Institutions in Norway," Working Papers 120, Princeton University, Department of Economics, Center for Economic Policy Studies..
    32. Marc Giannoni & Michael Woodford, 2004. "Optimal Inflation-Targeting Rules," NBER Chapters, in: The Inflation-Targeting Debate, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Svensson, Lars E.O., 2010. "Inflation Targeting," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 22, pages 1237-1302, Elsevier.
    2. Lars E.O. Svensson, 2004. "Targeting Rules vs. Instrument Rules for Monetary Policy: What is Wrong with McCallum and Nelson?," NBER Working Papers 10747, National Bureau of Economic Research, Inc.
    3. Lars E. O. Svensson, 2005. "Targeting versus instrument rules for monetary policy: what is wrong with McCallum and Nelson?," Review, Federal Reserve Bank of St. Louis, vol. 87(Sep), pages 613-626.
    4. Pelin Ilbas, 2006. "Optimal Monetary Policy rules for the Euro area in a DSGE framework," Working Papers of Department of Economics, Leuven ces0613, KU Leuven, Faculty of Economics and Business (FEB), Department of Economics, Leuven.
    5. Svensson, Lars E. O. & Williams, Noah, 2005. "Monetary policy with model uncertainty: distribution forecast targeting," Discussion Paper Series 1: Economic Studies 2005,35, Deutsche Bundesbank.
    6. Michael Paetz, 2007. "Robust Control and Persistence in the New Keynesian Economy," Quantitative Macroeconomics Working Papers 20711, Hamburg University, Department of Economics.
    7. Stefan Laséen & Lars E.O. Svensson, 2009. "Anticipated Alternative Instrument-Rate Paths in Policy Simulations," NBER Working Papers 14902, National Bureau of Economic Research, Inc.
    8. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    9. Lars E. O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters, in: The Inflation-Targeting Debate, National Bureau of Economic Research, Inc.
    10. Stefan Laséen & Lars E.O. Svensson, 2011. "Anticipated Alternative policy Rate Paths in Plicy Simulations," International Journal of Central Banking, International Journal of Central Banking, vol. 7(3), pages 1-35, September.
    11. Ms. Alina Carare & Mr. Robert Tchaidze, 2005. "The Use and Abuse of Taylor Rules: How Precisely Can We Estimate Them?," IMF Working Papers 2005/148, International Monetary Fund.
    12. Alexei Onatski & Noah Williams, 2010. "Empirical and policy performance of a forward‐looking monetary model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(1), pages 145-176, January.
    13. Eric Schaling & James Bullard, 2005. "Monetary Policy, Determinacy, and Learnability in the Open Economy," Computing in Economics and Finance 2005 362, Society for Computational Economics.
    14. Wohltmann, Hans-Werner & Winkler, Roland C., 2009. "Rational expectations models with anticipated shocks and optimal policy: a general solution method and a new Keynesian example," Economics Working Papers 2009-01, Christian-Albrechts-University of Kiel, Department of Economics.
    15. Laxton, Douglas & Pesenti, Paolo & Juillard, Michel & Karam, Philippe, 2006. "Welfare-based monetary policy rules in an estimated DSGE model of the US economy," Working Paper Series 613, European Central Bank.
    16. Lars E. O. Svensson, 2001. "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," Palgrave Macmillan Books, in: Deutsche Bundesbank (ed.), The Monetary Transmission Process, chapter 2, pages 60-111, Palgrave Macmillan.
    17. Siok Kun, Sek, 2009. "The impacts of economic structures on the performance of simple policy rules in a small open economy," MPRA Paper 25065, University Library of Munich, Germany.
    18. Lars E.O. Svensson, 2020. "What Rule for the Federal Reserve? Forecast Targeting," International Journal of Central Banking, International Journal of Central Banking, vol. 16(6), pages 39-95, December.
    19. Dennis, Richard, 2004. "Solving for optimal simple rules in rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 28(8), pages 1635-1660, June.
    20. Robert Tchaidze & Alina Carare, 2004. "The Use and Abuse of Taylor Rules: How precisely can we estimate them?," Econometric Society 2004 Latin American Meetings 132, Econometric Society.

    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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:819. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Joachim Winter (email available below). General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.