The other method, applied by the majority of central banks including the Riksbank, is to forecast how the economy will evolve over the next couple of years and adjust monetary policy accordingly. One complication here is that something unexpected can always happen, causing the economy to move in a different direction than that expected. For this reason the central bank must take account of different risks when setting the policy rate. The forecasts are produced by experts through the use of various statistical methods and models. The results are often presented in the shape of a main scenario and one or more alternative scenarios. A monetary policy that is based on forecasts requires more information about the economy than a rule-based policy, and according to its critics there is a risk that forecasters will overestimate their ability, perhaps leading to poorer results than would have been the case with a less complicated approach. Advocates of the method, on the other hand, say that we should make full use of the knowledge that we nevertheless have. Since a forecast-based monetary policy requires the analysis of many more variables than is the case for a simple rule, it is more difficult for external players to predict how the central bank is going to act. For this reason a forecast-based policy places high demands on the bank’s openness and transparency in relation to external parties, as well as on its ability to communicate. There are also other advantages associated with a forecast-based monetary policy.
The Supervisory Risk Assessment will incorporate supervisory judgment on all risk factors, aiming to evaluate measures and summarise in a comparable form across banks all potential sources of risk. This risk assessment will also be used for the portfolio selection to be undertaken as part of the balance sheet assessment. The second element, the Balance Sheet Assessment, will be carried out at a given point in time and on an accounting basis. This assessment will be broad and inclusive, covering credit and market exposures, on and off-balance sheet positions, domestic and significant non-domestic exposures. One key issue is going to be the capital threshold used for this exercise, which, in accordance with the definitions of the Capital Requirements Regulation and Capital Requirement Directive IV, based on Basel III recommendations, will take into account the need for a demanding threshold. The main content and details of this exercise will be made public in the next few days. The third element, the Stress Test, will review the major risks of banking groups under various scenarios, testing the sensitivity of bank balance sheets to hypothetical external shocks. The features of the stress test will be defined in conjunction with the EBA, and publicly disclosed at a later stage. The results of the assessment will be published once finished and prior to the ECB assuming its supervisory role. The ECB will manage and oversee the exercise in close cooperation with the National Authorities and with the support of an international consultancy firm.