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Communicating Monetary Policy Intentions - the Case of Norges Bank

Communicating Monetary Policy Intentions - the Case of Norges Bank . Amund Holmsen 16 May 2009 (with Jan F. Qvigstad, Øistein Røisland and Kristin Solberg-Johansen). Overview. What do we communicate? Interest rate forecasts four years on – a review of pros and cons Challenges.

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Communicating Monetary Policy Intentions - the Case of Norges Bank

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  1. Communicating Monetary Policy Intentions - the Case of Norges Bank Amund Holmsen 16 May 2009 (with Jan F. Qvigstad, Øistein Røisland and Kristin Solberg-Johansen)

  2. Overview What do we communicate? Interest rate forecasts four years on – a review of pros and cons Challenges

  3. Conclusion It seems to work well in Norway.

  4. Talking about the future… “…strong vigilance is therefore of the essence...” (Trichet, August 2007) “...and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." (FED, April 2009) “...the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010...”(BoC, April 2009)

  5. Changes in Norges Bank’s interest rate assumption 2001 - 2002 Constant interest rate 2003 - 2005 Markets’ interest rate expectations …with comments 2005 Our own interest rate forecast

  6. 90% 70% 50% 30% Ingredient 1: Baseline scenario (MPR 2/08) Key policy rate Output gap CPI CPI excl taxes and energy

  7. 90% 70% 50% 30% Ingredient 2: Shift scenarios Key policy rate Output gap Higher inflation Higher inflation CPI x taxes/energy Higher inflation

  8. Projected interest rate path MPR 2/08 MPR 1/08 90% 70% 50% 30%

  9. Ingredient 3: Delta accounting of the interest rate path

  10. Pros and cons – revisited

  11. Reviewing some counter-arguments Is conditionality misunderstood? Are policy makers constrained? Is it possible to decide on a whole path?

  12. The yield curve moves on economic news July 2008 Key policy rate Norges Bank forecast Norges Bank forecast in the previous report Implied forward rates day before report Implied forward rates after previous report

  13. Reviewing some counter-arguments Is conditionality misunderstood? Are policy makers constrained? Is it possible to decide on a whole path?

  14. Interest rate forecasts with fan chart from MPR 3/2008Percent 30% 50% 70% 90%

  15. Reviewing some counter-arguments Is conditionality misunderstood? Are policy makers constrained? Is it possible to decide on a whole path?

  16. Reviewing some pro-arguments Is the reaction function better anchored? Test 1: Are market rates reasonably aligned with our forecast? Test 2: Are there smaller jumps in market rates around policy announcements?

  17. b) June 2006 a) November 2005 Baseline scenario Forward rates Forward rates Baseline scenario d) March 2008 c) June 2007 Baseline scenario Baseline scenario Forward rates Forward rates

  18. Market rates as exogenous assumptions Interest rate forecasts Change in 12-month LIBOR krone rate from the day of a policy announcement to the following day, and averages for the two periods. Basis points.

  19. Fewer misunderstandings Easier to talk about the future Exit strategy as integrated part of the communication Credible interest rate forecast vs quantitative easing Reviewing some more pro-arguments

  20. Challenges Modelling optimal monetary policy Consistency Over time and accross states of the economy

  21. Alternative approaches Simple interest rate rule rt = art-1 + (1-a)[b1(Etpt+k-p*)+b2yt +b3Dyt] Optimal policy: Minimizing a loss function L = (π - π*)2 + λy2 + δ(r - r-1)2

  22. Simple rule rt = art-1 + (1-a)[b1(Etpt+k-p*)+b2yt +b3Dyt] Two approaches Coefficients optimized over unconditional loss Coefficients optimized over conditional loss We faced the “rules vs discretion” issue and had to take a stand!

  23. Forward looking Taylor rule vs Timeless In 2006 we were able to reproduce our forward-looking Taylor-rule forecast with optimal policy under timeless perspective with the loss function: Interest rate Timeless MPR 2/2006 Output gap Inflation Timeless Timeless MPR 2/2006 MPR 2/2006

  24. Ramsey and Timeless (baseline scenario) Key policy rate Ramsey Timeless Inflation Output gap Timeless Timeless Ramsey Ramsey

  25. Timeless with different λ’s Key policy rate λ=0.40 Timeless and Ramsey: - λ=0.30 - Weight change in interest rate=0.2 λ=0.20 Baseline scenario Inflation Output gap λ=0.20 λ=0.20 Baseline scenario λ=0.40 λ=0.40 Baseline scenario

  26. Current approach: Forecasts, alternative scenarios and ”interest rate account” Publish loss function (Svensson) Interest rate rule Target criterion (Woodford&Giannoni) (π - π*)+ θ(y-y-1)=0 Alternative approaches to commitment

  27. The experience is good The conditionality and the uncertainty in the forecast seem well understood Monetary policy appears to have become more predictable The policy discussion is brought closer to the research frontier Still early. If nothing else – better economists Conclusions

  28. Communicating Monetary Policy Intentions - the Case of Norges Bank Amund Holmsen 16 May 2009 (with Jan F. Qvigstad, Øistein Røisland and Kristin Solberg-Johansen)

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