In practice, these fan charts are constructed on the basis of the experience of past forecast errors and the MPC’s judgement of the present degree of uncertainty. Given that the period of the MPC has been characterised by a time of unusual stability followed by one of unusual volatility, the more subjective element of this approach has proved to be fully justified. However, an alternative guide to the MPC’s internal deliberations on this issue might also be provided by a more explicit consideration of a range of approaches to measurement of the output gap and its impact on inflation. The policy horizon In considering the policy decision month by month, the MPC has tended to put weight on the projection for CPI inflation around two years ahead. This has not meant simply changing policy in response to whatever the central forecast is at that horizon; policy decisions will also take into account the pattern of deviations from the target over the whole three-year forecast period, and, importantly, the balance of risks around the central projection. There are clear and familiar benefits to having a forward-looking policy regime. A Taylor rule regime based on current data would have the considerable disadvantage that it would be more likely to result in volatility of output growth, and also that policy might tend to react too strongly to unreliable current data. But it is less clear precisely how far ahead the policy horizon should be.
The new concept has so far proven to be very effective in a turbulent environment, enabling the SNB to react to major shocks independently and flexibly. Moreover, it has strengthened confidence in the successful preservation of monetary stability. Compared with the SNB’s last quarterly assessment in March, many indicators now suggest strongerthan-expected growth. However, high commodity prices, rising capital market interest rates and turbulences in the equity and foreign exchange markets may also present new risks. On the whole, we still consider our strategy of gradual normalisation to be appropriate. Should the environment change, however, the SNB will not hesitate to review its monetary stance and adjust it, if necessary. The current cyclical boom should not obscure the fact that the Swiss domestic market still needs further structural reforms to ensure sustained economic growth, thus safeguarding our prosperity and preparing the economy for the demographic challenges ahead. BIS Review 56/2006  1