BIS Review 6/2004  3  The choice of horizon for monetary policy implicitly provides some information about the central bank’s loss function.8 A central bank that places considerable emphasis on inflation and little emphasis on the real economy will choose a short horizon. A central bank that places considerable emphasis on the real economy will choose a long horizon. Behind the choice of a horizon of normally two years lies a perception of how the interest rate affects developments in inflation and output, and the central bank’s trade-off between variations in these two variables. According to theories on optimal monetary policy, the horizon should vary and partly depend on the size and duration of disturbances to the economy. For some types of disturbances, such as demand shocks, the optimal choice may be to achieve the inflation target relatively rapidly. For other types of disturbances, such as cost shocks, a longer horizon may be optimal, provided that confidence in monetary policy is not in jeopardy. Even though, according to the theory, the horizon should be variable, there are some advantages to maintaining a fairly firm horizon that have not been as prominent in the literature. It is crucial that the public and market participants understand how the central bank sets the interest rate in order to contribute to confidence and credibility in monetary policy. According to the principle normally followed by Norges Bank, the interest rate is set with a view to achieving inflation of 2½ per cent at the two-year horizon.
BIS Review 76/2009  11  Figure 9 Durable goods sales (index, average January 1996 - April 2009=100) 230  230  190  190  150  150  110  110  70  70  30  30  96  97  98  99  00  01  02  03  New automobiles' sales (units)  04  05  06  07  08  09  Capital goods imports (nominal)  Sources: Asociación Nacional Automotriz de Chile (ANAC) and Central Bank of Chile. Figure 10 Economic perception  (diffusion indexes, percent) Business confidence (1)  Consumers' confidence (2)  70  140  120  60  60  120  100  50  50  100  80  40  40  80  60  30  30  60  40  20  20  40  20  10  07 Brazil U.S. Japan  Jul. 08  China Mexico Eurozone  Jul. 09 S. Korea  07 Brazil China U.S. Mexico  Jul. 08  Jul. 09  S. Korea Japan Eurozone  (1) S. Korea is anchored in 100. (2) Series of Japan, Eurozone and S. Korea anchored in 50. The rest of the series are indexes with base January 2007=100. Source: Bloomberg. 12  BIS Review 76/2009  Figure 11 Stock market indicators (*) (Index 01/03/2005 =100) 400  Subprime crisis erupts  350  Bear Stearns  400  Lehman, AIG, etc.