It is found that the aforementioned claim is incorrect. The purpose of creating economic forecasts by central banks (CB) is not simplifying the job of explaining monetary policy to the public. This essay will first define what is economic forecasts and how do central banks make forecasts. After that, the essay will discuss the major purposes of creating economic forecasts by central banks, supported by empirical evidence.
Definition of terms
Economic forecast is any statement about the future, which can be created by methods ranging from well-tested system of hundreds of econometrically-estimated equations to approaches with scarcely any observable basis (Clements and Hendry, 1998).
In central banks, economic forecasts are usually done by the central bank staffs and are presented to the policy makers as a foundation for policy discussions. However, the forecasts need not represent the predictions of any individual policymaker (Reifschneider, Stockton and Wilcox, 1996). For monetary decisions, forecast targets usually include inflation, GDP growth, investment, consumer spending and wages while the length of the forecast horizon mainly depends on how long it is believed to take for changes in policy instruments to influence the economy (Robertson, 2000).
Major purposes of creating economic forecasts by central banks
Some people may argue that central banks create economic forecasts because the forecasts simplify the job of explaining monetary policy to the public. However, this claim is untenable. Undoubtedly, economic forecasts can help simplifying the job of explaining policy to the public. Nevertheless, central banks can adopt many other effective approaches to simplify the task of clarifying policy to the public such as publishing clear reports and holding public conferences (Fracasso, Genberg and Wyplosz, 2003). Therefore, it is unpersuasive to claim that simplifying explanations is the real intention of the central banks.
In fact, researchers point out that the major purposes of making economic forecasts by central banks are 1) analyzing available policy options and predicting the likely consequence of each choice, 2) assessing the developments in real activities and 3) anchoring the expectations of professional agents and households in order to reinforce the effectiveness of monetary policy (Weber, 2009). In the following sections, these two purposes will be discussed in detail.
Purpose 1: Analyzing available policy options
One of the major purpose for the central bank to create economic forecasts is to analyze available policy choices and estimate the likely consequence of each option. It is well recognized that there are long and variable lags in the monetary policy transmission mechanism (Havranek and Rusnak, 2013). In the other words, central banks cannot influence current inflation and output but can only affect future economic outcomes. As a result, monetary policy need to be forward-looking and good economic forecasts usually act as the foundation of policy discussions.
Central bank staffs usually will not provide single-option forecasts. Instead, they will frame the forecasts in a way that could show available policy choices and the respective consequences. This is very useful for policy makers as “baseline simulation” or “alternative simulations” are provide as a basis for them to make decisions on monetary policy. As mentioned by Janet Yellen, the 15th Chairwoman of the Federal Reserve, FOMC will analyze how different monetary policy strategies would affect projected economic outcomes and risks in order to come up with an appropriate stance of monetary policy (Yellen, 2017). For example, before deciding on the appropriate stance of monetary policy, FOMC participants will firstly consider a voluminous amount of information such as labor market conditions, financial markets and global economic environment. After that, they will prepare estimations on a quarterly basis of the most likely paths of important economic variables under their own evaluations of suitable monetary policy. Finally, the Committee will decide on the most appropriate monetary policy to implement at every meeting. The policy making procedures of the Federal Reserve clearly show that economic forecasts could help central bankers to make better decisions by analyzing available policy options and the likely consequences.
Purpose 2: Assessing the development in real activities
Another major purpose for central banks to make economic forecasts is assessing the development in real activities so that adjustments on monetary policy could be made swiftly if necessary.
Recently, many central banks have been spending a lot of resources on developing short-term forecasting model, including the so called “now-casting” models (Weber, 2009). The purpose is to assess the near term and current development in real activities. By doing so, the central banks can make adjustments on their monetary stance promptly if there is anything wrong. For example, the FOMC is now a data-driven committee which makes decisions and provides guidance meeting by meeting based on the forecasts made on the latest released actual data (Dunsmuir, 2016). This shows that the assessment on the short-term development in real activities is very important for the central banks to make adjustments on policy stance. And economic forecasting serves as an essential tool for them to get a sense of the near term or current development of the economy.
Purpose 3: Anchoring the expectations of professional agents and households
Last but not least, releasing economic forecasts to the public could anchor the expectations of professional agents and households so the effectiveness of the monetary policy could be enhanced.
Researchers point out that central bank’s economic forecasts can affect the predictions of professional agents effectively. For instance, Fujiwara studied the influence of Bank of Japan (BOJ)’s publication of forecasts and he found out that professional forecasters were affected heavily by the forecasts made by BOJ and how did BOJ clarify its views on future economic development (Fujiwara, 2005). Geraats from the European Central Bank (ECB) also pointed out that the public was uncertain about the central bank’s preferences and the publication of central bank forecasts could reduce such uncertainties, leading to greater predictability of the responses of firms and households to the implemented monetary policy (Geraats, 2001). If the central banks didn’t release their forecasts and clarify their monetary stance, professional agents and households might act in the wrong directions that the central banks would like to see. The evidence clearly shows that the release of economic forecasts by the central banks can anchor the expectations of professional agents and households so that the efficacy of the monetary policy can be reinforced.
In short, it is found that the aforementioned claim is incorrect. The purpose of creating economic forecasts by central banks is not simplifying the job of explaining monetary policy to the public. In fact, the major functions of making economic forecasts by central banks are 1) analyzing available policy options and predicting the likely result of each choice, 2) gauging the developments in real activities and 3) anchoring the expectations of professional agents and households in order to strengthen the effectiveness of monetary policy.