Uncertainty in theory Our forecasting ability is thus very limited one year ahead and almost non-existent two and three years ahead. The best forecast we can then make is normally to assume that inflation will be 2 per cent in two and three years’ time. But that is not much help when shaping monetary policy. At the same time it is reasonable to assume that monetary policy will actually affect inflation two and three years ahead and that we therefore need forecasts as a basis for monetary policy. So what can we do to manage the uncertainty in monetary policy? In a linear model, where inflation depends on the interest rate and an uncertainty term with a mean value of zero, where the parameters are known and constant, and with a quadratic objective function (loss function), the uncertainty does not matter with regard to which interest rate should be chosen to minimise the loss function.10 It is enough to take into  8  Prior to 2007 we first based the forecasts on a constant repo rate and then on estimated market expectations. It is possible that we could have made better forecasts with a different interest rate assumption. To be able to comment more strongly on forecasting ability, one should actually base the calculations on longer periods of time. One should also compare with the historical series available at the time the forecasts were made. 9  The figure is based on the period 2005–2010. 10  See, for instance, L.E.O.
It is quite simply impossible to make any reliable forecasts for two and three years ahead. My opinion is that it is normally fairly meaningless to have a firm opinion of what will happen in two and three years’ time. But there are exceptions, particularly in situations where resource utilisation is very low. During 2008–2009 we assessed that the repo rate would be at an exceptionally low level for one year and we backed this up by lending around SEK 300 billion to the banks at this low interest rate for one year. We should continue to report a main scenario for economic developments and the repo rate over the coming three years, a scenario where inflation approaches 2 per cent and resource utilisation approaches a normal level. But we should regard this merely as a potential scenario. It is important that monetary policy follows a predictable pattern. We endeavour to avoid surprising the market. This means that we normally change the repo rate and the reporate path in gradual small steps, where the steps are due to new information received since the most recent monetary policy meeting, and that we react in roughly the same way to the same type of changes in the new information. Such stability means that we can avoid causing problems on the financial markets, and that we can have a greater impact on the markets when an unexpected event occurs. We should also continue to analyse the consequences of various sequences of events.