The Central Banker as a Risk Manager: Quantifying and Forecasting Inflation Risks

47 Pages Posted: 25 Jul 2003

See all articles by Lutz Kilian

Lutz Kilian

University of Michigan at Ann Arbor - Department of Economics; Centre for Economic Policy Research (CEPR)

Simone Manganelli

European Central Bank (ECB)

Date Written: June 2003

Abstract

In deciding a monetary policy stance, central bankers need to evaluate carefully the risks the current economic situation poses to price stability. We propose to regard the central banker as a risk manager who aims to contain inflation within pre-specified bounds. We develop formal tools of risk management that may be used to quantify and forecast the risks of failing to attain that objective. We illustrate the use of these risk measures in practice. First, we show how to construct genuine real time forecasts of year-on-year risks that may be used in policy-making. We demonstrate the usefulness of these risk forecasts in understanding the Fed's decision to tighten monetary policy in 1984, 1988, and 1994. Second, we forecast the risks of worldwide deflation for horizons of up to two years. Although recently fears of worldwide deflation have increased, we find that, as of September 2002, with the exception of Japan, there is no evidence of substantial deflation risks. We also put the estimates of deflation risk for the United States, Germany and Japan into historical perspective. We find that only for Japan there is evidence of deflation risks that are unusually high by historical standards.

Keywords: Risk, forecast, monetary policy, price stability, inflation, deflation

JEL Classification: C22, E31, E37, E52, E58

Suggested Citation

Kilian, Lutz and Manganelli, Simone, The Central Banker as a Risk Manager: Quantifying and Forecasting Inflation Risks (June 2003). CEPR Discussion Paper No. 3918. Available at SSRN: https://ssrn.com/abstract=428084

Lutz Kilian (Contact Author)

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States
734-764-2320 (Phone)
734-764-2769 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Simone Manganelli

European Central Bank (ECB) ( email )

Kaiserstrasse 29
Frankfurt am Main, 60311
Germany

HOME PAGE: http://www.simonemanganelli.org

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