Zdeněk Tůma: Forecasting and its role as an information source in the decision-making of the central bank Speech by Mr Zdeněk Tůma, Governor of the Czech National Bank, at the Forecasting Dinner 2005, Czech National Bank, Prague, 18 February 2005. *  *  *  Ladies and gentlemen, Last year when I was speaking on the occasion of the Forecasting Dinner, I discussed several points connected with the forecasting processes at central banks and at the CNB in particular. Tonight I shall talk about some aspects of uncertainty in forecasting and in particular about the role market forecasts can play as an information source in the decision-making of the central bank. The essential question I have in mind is to what extent should the central bank follow market forecasters’ expectations about the future development of the economy. In other words, should the central bank, in order to achieve its target, follow the market’s expectations or can it surprise the market from time to time? To your common knowledge, the CNB nowadays operates under the inflation targeting regime, which is a monetary policy regime that considers the forecasting process to be the heart of monetary policy decision-making. Although the forecasting process pays main attention to the future development of prices, this does not necessarily mean that central bankers are obsessed with inflation. In fact, inflation targeting requires us to look for and use a broad range of information, including market expectations.
On the other hand, since the inflation forecast is not only an important internal decision-making tool, but also a crucial communication device, market participants have a good knowledge of the central bank’s forecast and can compare their own view on the economy with the central bank’s one. This implies that both the central bank and the market are well informed about each other’s forecast. It is clear that a huge portion of uncertainty is inherent to any practical forecasting. Moreover, from the monetary policy perspective this uncertainty is complicated by the fact that the results of today’s monetary policy action will be effective with a significant lag. On top of that, from the economic theory we know not only that today’s monetary policy decision is important, but also that the expectation about future monetary policy has an important impact. With a certain degree of simplification we can state that in general any future value of inflation depends on three main factors. These are the current state of the economy and its underlying inflationary pressures, current and future monetary policy actions and, of course, future economic shocks. Consequently, the surrounding uncertainty can also be divided into similar parts. Let me first shortly address the last point, something we can call the “shocks” uncertainty. It is necessary to admit that both today’s central bank forecast and today’s central bankers’ decision are deterministic from this point of view.