Working Paper: CEPR ID: DP13949
Authors: Lars E.O. Svensson
Abstract: How would the policy rule of forecast targeting work for the Federal Reserve? To what extent is the Federal Reserve already practicing forecast targeting? Forecast targeting means selecting a policy rate and policy-rate path so that the forecasts of inflation and employment"look good," in the sense of best fulfilling the dual mandate of price stability and maximum employment, that is, best stabilize inflation around the inflation target and employment around its maximum level. It also means publishing the policy-rate path and the forecasts of inflation andemployment forecasts and, importantly, explaining and justifying them. This justification may involve demonstrations that other policy-rate paths would lead to worse mandate fulfillment. Publication and justification will contribute to making the policy-rate path and the forecastscredible with the financial market and other economic agents and thereby more effectively implement the Federal Reserve's policy. With such information made public, external observers can review Federal Reserve policy, both in real time and after the outcomes for inflation andemployment have been observed, and the Federal Reserve can be held accountable for fulfilling its mandate. In contrast to simple policy rules that rely on very partial information in a rigid way, such as Taylor-type rules, forecast targeting allows all relevant information to be takeninto account and has the flexibility and robustness to adapt to new circumstances. Forecast targeting can also handle issues of time consistency and determinacy. The Federal Reserve is arguably to a considerable extent already practicing forecast targeting.
Keywords: Flexible Inflation Targeting; Monetary Policy Rules; Discretion and Commitment
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| forecast targeting (C53) | stabilization of inflation (E63) |
| forecast targeting (C53) | stabilization of unemployment (J64) |
| policy rate and path (E43) | forecasts of inflation (E37) |
| policy rate and path (E43) | forecasts of unemployment (E27) |
| forecasts of inflation and unemployment (E27) | fulfillment of dual mandate (H19) |
| flexibility of policy approach (E60) | effectiveness in achieving Federal Reserve's goals (E52) |
| publication and justification of policy rate path (E52) | market expectations (D84) |
| market expectations (D84) | better economic outcomes (P17) |
| forecast targeting (C53) | enhanced accountability and credibility (G38) |
| forecast targeting vs Taylor-type rules (C53) | economic stability outcomes (E63) |