Forecast Uncertainty and the Bank of England Interest Rate Decisions

56 Pages Posted: 8 Jun 2016

Date Written: 2010

Abstract

To assess the Bank of England Monetary Policy Committee decisions about the Official Bank Rate under forecast uncertainty, I estimate simple forecast-based interest rate rules augmented by the forecast standard deviations recovered directly from the Inflation Report fan charts. I find that interest rate decisions react to deviations of the medium-term forecasts for inflation from target in order to pursue the inflation target. Forecast inflation uncertainty has a strongly intensifying effect on this reaction. Information from output growth is utilized in the form of near-term forecasts. The associated forecast uncertainty of output growth has an attenuating effect on the interest rate reaction. When accounting for asymmetries in forecast uncertainty I find that forecast upward risks to inflation contribute to the intensifying effect of forecast inflation uncertainty. The corresponding downward risks have no significant impact. As regards output growth, asymmetries in the forecast uncertainty have no significant impact on the interest rate reaction at all. 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.

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 (2010). Bundesbank Series 1 Discussion Paper No. 2010,27, Available at SSRN: https://ssrn.com/abstract=2785392 or http://dx.doi.org/10.2139/ssrn.2785392

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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