Some Reflections on the Interactions Between the Bank of England's Forecasts and the Mpc's Policy Decisions (Monetary Policy Committee‪)‬

The purpose of this paper is to precis a couple of current research studies, which relate to the interaction between forecasts, the policy response to those forecasts by the Bank of England and the Monetary Policy Committee, and outcomes. Most economists are now aware--or should be--of the Inflation Report that the Monetary Policy Committee produces, and what are known as the 'fan charts,' showing the expected forecast of inflation and also of output growth. These are based on the conditional assumption that interest rates are held constant, after the change in interest rates made at the previous Monetary Policy Committee meeting, over the next few quarters. There is also a forecast that is done on the basis that the path of interest rates follows the path implied by the money market yield curve. For a variety of reasons, which will be the subject of yet another research exercise, that latter forecast has become more important since August 2004. Such a fan chart can only be constructed if one has lying behind it the various moments of the distribution; thus one needs to have the central moments, the mean, mode and median. These are not the same if there is a skew in the forecast; and there has been some skewness in recent forecasts, but these have been slight, so that the difference between the mode, the mean and the median has been fairly small. So, in this paper, I shall concentrate on the modal forecast. Such forecasts of the three central tendencies, plus the standard deviation and the skew are published by the Bank of England, about two weeks after the Inflation Forecast is published. The reason for that delay is not that they do not have these data, because they have to have them in order to prepare the fan chart. The reason is to try and wean the Press, and commentators and observers more generally, from only worrying about the central tendency, which is not actually reported in the Inflation Report, and to think much more about the probabilities of the distribution, a stochastic approach.