The macroeconomic projections by Eurosystem staff constitute an important input into the monetary policy decisions, because they are a way of organising a large amount of information and they help to create a consistent picture of possible future developments. However, the economic projections cannot encompass or even reflect all the complexities, conditioning factors, nuances and the multi-dimensional nature of a comprehensive assessment of the risks to price stability on which monetary policy decisions need to be based. While the information synthesised from various indicators serves as an important input into the decision-making process, the Governing Council of the ECB does not take decisions only on the basis of projections. The Governing Council’s “judgement” must eventually come into play in order to assess the likelihood of the alternative scenarios suggested by the economic analysis. This is particularly important when it is quite unclear how a certain situation will evolve, as is the case sometimes with sharp movements in asset prices. Related to this, attempts to base monetary policy decisions solely on inflation forecasts would involve significant limitations. Notably, they would entail an inefficient use of information, since every forecast, or any composite index of indicators, is based on one possible scenario and one combination of assumptions. In the end, monetary policy requires judgement on the part of the policy-maker to assess  BIS Review 67/2004  5  not only the plausibility of all possible scenarios, but also the nature of the shocks and the best policy reaction in order to deal with this uncertain environment.
A partial representation of the economic structure can only partially help in monetary policy decision-making, notably in real time. For instance, it is very difficult to find empirical models that allow for an integral view of both non-financial (‘real’) and monetary-financial phenomena. So, it may be impossible to arrive at a convincing explanation of the origin and propagation of a significant financial shock, say, on the basis of sets of equations that do not elaborate on the role of the financial sector or account for only tenuous links between that sector and the rest of the economy. Another example is provided by the many pitfalls that come with using “synthetic” indicators of inflationary pressure. The most famous of these “synthetic” indicators is the so-called “output gap”. The “output gap” can be defined as a measure of the deviation of the aggregate output of an economy from the maximum level that would be consistent with price stability. This maximum level is then the “potential output”. When current output is above potential, the pressure on the scarce resources should then translate into an increase in prices, that is, inflation. In the real world, the monetary authority constantly faces the challenge of observability and measurement. Unfortunately, we cannot “assume” to know the “potential output”. The best we can do is to try to “estimate” the output gap by using observations of many other correlated variables. We all know how imprecise and model-dependent this “estimated” measure can be.