The CNB changes its type of inflation forecast

Central banks that target inflation use essentially two types of inflation forecast as the basis for their monetary policy decisions. In addition to a forecast constituting the most likely future economic scenario, a "conditional inflation forecast" is often used. The latter simulates future trends under the not-necessarily-realistic assumption that the central bank will not alter the settings of its monetary policy instruments. The former is sometimes referred to as the "unconditional forecast" to differentiate it from the "conditional forecast", despite the fact that this unconditional forecast is conditional on a whole range of assumptions, as is every forecast of the complex evolution of real economic systems. To date, the key basis for the CNB Bank Board's decisions has been the forecast based on the assumption that monetary policy instruments will not change. By comparing the values of this forecast for the period of most effective transmission (approximately 12-18 months ahead) with the corresponding period of the target range it has been possible in this regime to assess what changes in monetary policy settings should be made at any given moment to prevent inflation from deviating from the target band in the period of most effective transmission.

In parallel with the "conditional forecast", the CNB's Monetary and Statistics Department (MSD) some time ago started preparing a forecast of the most likely future economic scenario. This forecast differs in principle from the "conditional forecast" in that it simulates the workings of the entire economy including monetary policy. The model on which this forecast is based contains a simple central bank reaction function which is consistent with the definitions of the CNB's objectives and which generates an implied interest rate trajectory. However, this trajectory cannot be considered binding as regards the future path of interest rates. There are two reasons for this. First, the economic outlook - and consequently the reaction of the central bank - can change in the light of new information received after the forecast is published. And second, the model does not perfectly describe the workings of the economy.

Now that the MSD has completed work on a forecasting system incorporating the reactions of the central bank, this type of forecast has become (as from July 2002) the primary source material for the CNB Bank Board's decision-making. This part of the Inflation Report describes the forecast used as the basis for monetary policy decision-making at the end of July 2002. The quarterly interval of the forecast remains unchanged, so that the next forecast will be compiled in October 2002.