Inflation Targeting in Practice: Models, Forecasts, and Hunches

Abstract

This paper reviews the role that model-based forecasts play in the monetary policy process in the United Kingdom, with particular reference to the Bank of England’s new quarterly model and continuing research into other statistical approaches. The Bank’s models provide a consistent framework for considering alternative scenarios and risks but judgement always plays a large role in constructing forecasts. It is hard to say precisely how important forecasts are in driving policy decisions, but there is some evidence that the rethink of key issues during the forecast round has been a source of policy surprises. Forecasts also play a central part in communicating the Monetary Policy Committee’s thinking to the outside world. But forecasts are highly fallible. So the MPC’s forecast centered approach to inflation targeting has gone hand in hand with a determined effort to illustrate the wide range of uncertainties around its central projections.