Forecast Uncertainty and the Bank of England Interest Rate Decisions

56 Pages Posted: 9 Aug 2015

Date Written: January 1, 2013

Abstract

To assess the Bank of England’s Monetary Policy Committee decisions on the official bank rate under forecast uncertainty, I estimate simple forecast-based interest rate rules augmented by the exact forecast standard deviations recovered directly from the Inflation Report fan charts. I find that forecast inflation uncertainty strongly intensifies the reaction of the interest rate decisions to a forecast deviation of inflation from target. Conversely, forecast output growth uncertainty attenuates the reaction of the interest rate decisions to a forecast deviation of output growth from its long-run mean. Asymmetries in forecast uncertainty are highly relevant for inflation. Forecast upward risks to inflation contribute strongly to the intensifying effect of forecast inflation uncertainty, while forecast downward risks have hardly any significant impact. Moreover, I find that forecast risks to inflation have a direct effect on the interest rate decisions, in particular when inflation is forecast close to target. Uncertainty forecasts obtained from the Survey of External Forecasters, though, contain no explanatory power.

Keywords: Forecast Uncertainty, Forecast Risk, Bank of England, Monetary Policy Committee, Forecast-based Interest Rate Rules

JEL Classification: C53, E43, E47

Suggested Citation

Schultefrankenfeld, Guido, Forecast Uncertainty and the Bank of England Interest Rate Decisions (January 1, 2013). Studies in Nonlinear Dynamics and Econometrics, Vol. 17, No. 1, 2013, Available at SSRN: https://ssrn.com/abstract=2633949 or http://dx.doi.org/10.2139/ssrn.2633949

Guido Schultefrankenfeld (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Research Centre
Frankfurt/Main, DE Hesse 60431
Germany

HOME PAGE: http://www.bundesbank.de/research_guido_schultefrankenfeld

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