Communicating Monetary Policy Intentions
- the Case of Norges Bank
Amund Holmsen
16 May 2009
(with Jan F. Qvigstad, Øistein Røisland
and Kristin Solberg-Johansen)
Overview
1. What do we communicate?
2. Interest rate forecasts four years on
– a review of pros and cons
3. Challenges
Conclusion
It seems to work well in Norway.
Talking about the future…
 “…strong vigilance is therefore of the essence...”
(Trichet, August 2007)
 “...and anticipates that economic conditions are likely to
warrant exceptionally low levels of the federal funds rate for
an extended period."
(FED, April 2009)
 “...the target overnight rate can be expected to remain at its
current level until the end of the second quarter of 2010...”
(BoC, April 2009)
Changes in Norges Bank’s interest rate assumption
 2001 - 2002 Constant interest rate
 2003 - 2005 Markets’ interest rate expectations
…with comments
 2005
Our own interest rate forecast
Ingredient 1: Baseline scenario (MPR 2/08)
90%
70%
50%
9
8 Key policy rate
7
6
5
4
3
2
1
0
2006 2007 2008 2009 2010 2011
7
30%
6
5
9
8
7
6
5
4
3
2
1
0
4
7
CPI
6
Output gap
5
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
2006 2007 2008 2009 2010 2011
-3
5
4
5
CPI excl taxes and
energy
4
5
5
4
4
3
3
3
3
2
2
2
2
1
1
1
1
0
2006
0
0
2006 2007 2008 2009 2010 2011
0
2007
2008
2009
2010
2011
Ingredient 2: Shift scenarios
9
Key policy rate
8
7
Higher inflation
6
5
4
3
2
1
0
2006 2007 2008 2009
9
8
7
6
5
4
3
2
1
0
2010 2011
5
5
Output gap
4
4
3
3
2
2
1
1
Higher inflation
0
0
-1
-1
-2
-2
-3
2006
5
-3
4
90%
2007
2008
2009
2010
2011
5
CPI x taxes/energy
4
Higher inflation
3
3
2
2
1
1
0
2006
0
70%
50%
30%
2007
2008
2009
2010
2011
Projected interest rate path
9
9
8
8
MPR 2/08
7
7
6
6
5
5
4
4
MPR 1/08
3
3
2
2
1
0
2006
90%
70%
50%
1
30%
0
2007
2008
2009
2010
2011
Ingredient 3: Delta accounting of the interest rate path
2,0
2,0
1,5
1,5
1,0
1,0
0,5
0,5
0,0
0,0
-0,5
-0,5
Higher demand in Norw ay
Higher inflation in Norw ay
Higher interest rates abroad
Higher risk premium in the money market
Low er grow th abroad
Changes in the interest rate path
-1,0
-1,5
-1,0
-1,5
-2,0
-2,0
08 Q3
09 Q1
09 Q3
10 Q1
10 Q3
11 Q1
11 Q3
Pros and cons – revisited
Reviewing some counter-arguments
 Is conditionality misunderstood?
 Are policy makers constrained?
 Is it possible to decide on a whole path?
The yield curve moves on economic news
8
7
July 2008
6
5
4
3
Key policy rate
Norges Bank forecast
Norges Bank forecast in the previous report
Implied forward rates day before report
2
1
Implied forward rates after previous report
0
2005
2006
2007
2008
2009
2010
2011
2012
Reviewing some counter-arguments
 Is conditionality misunderstood?
 Are policy makers constrained?
 Is it possible to decide on a whole path?
Interest rate forecasts with fan chart from MPR 3/2008
Percent
30%
50%
70%
90%
Reviewing some counter-arguments
 Is conditionality misunderstood?
 Are policy makers constrained?
 Is it possible to decide on a whole path?
Reviewing some pro-arguments
 Is the reaction function better anchored?
 Test 1: Are market rates reasonably aligned with our
forecast?
 Test 2: Are there smaller jumps in market rates
around policy announcements?
a) November 2005
b) June 2006
8
8
7
7
6
6
5
5
Forward rates
4
4
3
3
2
2
Baseline scenario
1
1
0
0
2006
2007
2008
2009
8
7
6
5
4
3
2
1
0
2006
c) June 2007
d) March 2008
8
7
6
5
4
3
2
1
0
2006
Baseline scenario
Forward rates
2007
2008
2009
2010
8
7
6
5
4
3
2
1
0
8
7
6
5
4
3
2
1
0
2007
Baseline scenario
Forward rates
2007
2008
2009
Baseline scenario
Forward rates
2008
8
7
6
5
4
3
2
1
0
2009
8
7
6
5
4
3
2
1
0
70
60
50
40
Market rates as exogenous assumptions
30
Interest rate forecasts
20
10
0
4.4.01
27.2.02
22.1.03
28.1.04 15.12.04 2.11.05
27.9.06
15.8.07
25.6.08
Change in 12-month LIBOR krone rate from the day of a policy announcement to the
following day, and averages for the two periods. Basis points.
Reviewing some more pro-arguments
 Fewer misunderstandings
 Easier to talk about the future
 Exit strategy as integrated part of the communication
 Credible interest rate forecast vs quantitative easing
Challenges
 Modelling optimal monetary policy
 Consistency
 Over time and accross states of the economy
Alternative approaches
 Simple interest rate rule
rt = art-1 + (1-a)[b1(Etpt+k -p*)+b2yt +b3Dyt]
 Optimal policy: Minimizing a loss function
L = (π - π*)2 + λy2 + δ(r - r-1)2
Simple rule
rt = art-1 + (1-a)[b1(Etpt+k -p*)+b2yt +b3Dyt]
 Two approaches
 Coefficients optimized over unconditional loss
 Coefficients optimized over conditional loss
 We faced the “rules vs discretion” issue and had to take
a stand!
Forward looking Taylor rule vs Timeless
7
In 2006 we were able to reproduce our
forward-looking Taylor-rule forecast with
optimal policy under timeless perspective with
the loss function:

7
Interest rate
6
Timeless
5
5
MPR 2/2006
4
4
3
3
L  E t  bk  pt  k  p*   0.3y 2t  k  0.2(i t  k  i t  k 1 ) 2  2


k 0
3
2
Inflation
3
3
2
1
1
0
2006
0
2007
2008
3
Timeless
2
2
2009
Output gap
Timeless
2
6
MPR 2/2006
1
2
1
MPR 2/2006
1
0
2006
0
0
-1
-1
-2
2006
-2
1
0
2007
2008
2009
2007
2008
2009
Ramsey and Timeless (baseline scenario)
Key policy rate
7
7
Ramsey
6
6
5
5
Timeless
4
Inflation
3
4
3
3
2
2
1
1
0
2006
0
2007
3
2008
2009
2010
3
Output gap
3
Timeless
Timeless
2
2
2
1
Ramsey
1
0
2006
2
1
0
0
2007
2008
2009
2010
0
Ramsey
1
-1
-1
-2
2006
-2
2007
2008
2009
2010
Timeless with different λ’s
Key policy rate
7
7
λ=0.40
6
Timeless and Ramsey:
- λ=0.30
- Weight change in
interest rate=0.2
6
5
5
4
4
λ=0.20
3
2
2
1
1
0
2006
0
Inflation
3
3
Baseline
scenario
2007
3
λ=0.20
2008
2009
2010
Output gap
3
λ=0.20
2
2
2
2
1
λ=0.40
0
1
Baseline
scenario
1
λ=0.40
0
1
Baseline
scenario
0
2006
3
0
2007
2008
2009
2010
-1
-1
-2
2006
-2
2007
2008
2009
2010
Alternative approaches to commitment
 Current approach: Forecasts, alternative scenarios
and ”interest rate account”
 Publish loss function (Svensson)
 Interest rate rule
 Target criterion (Woodford&Giannoni)
(π - π*) + θ(y-y-1)=0
Conclusions
 The experience is good
 The conditionality and the uncertainty in the
forecast seem well understood
 Monetary policy appears to have become more
predictable
 The policy discussion is brought closer to the
research frontier
 Still early. If nothing else – better economists
Communicating Monetary Policy Intentions
- the Case of Norges Bank
Amund Holmsen
16 May 2009
(with Jan F. Qvigstad, Øistein Røisland
and Kristin Solberg-Johansen)