1. Communicating Monetary Policy Intentions - the Case of Norges Bank Amund Holmsen 16 May 2009 (with Jan F. Qvigstad, Øistein Røisland and Kristin Solberg-Johansen)

2. Overview 1.What do we communicate? 2.Interest rate forecasts four years on – a review of pros and cons 3.Challenges

3. Conclusion It seems to work well in Norway.

4. Talking about the future…  “…strong vigilance is therefore of the essence...” (Trichet, August 2007)  “...and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." (FED, April 2009)  “...the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010...” (BoC, April 2009)

5. Changes in Norges Bank’s interest rate assumption  2001 - 2002 Constant interest rate  2003 - 2005 Markets’ interest rate expectations …with comments  2005 Our own interest rate forecast

6. 90% 70% 50% 30% Ingredient 1: Baseline scenario (MPR 2/08) Output gap CPI excl taxes and energy CPI Key policy rate

7. 90% 70% 50% 30% Ingredient 2: Shift scenarios Key policy rate Output gap CPI x taxes/energy Higher inflation

8. MPR 1/08 MPR 2/08 90% 70% 50% 30% Projected interest rate path

9. Ingredient 3: Delta accounting of the interest rate path

10. Pros and cons – revisited

11. Reviewing some counter-arguments  Is conditionality misunderstood?  Are policy makers constrained?  Is it possible to decide on a whole path?

12. The yield curve moves on economic news Implied forward rates after previous report Norges Bank forecast Key policy rate Implied forward rates day before report Norges Bank forecast in the previous report July 2008

13. Reviewing some counter-arguments  Is conditionality misunderstood?  Are policy makers constrained?  Is it possible to decide on a whole path?

14. Interest rate forecasts with fan chart from MPR 3/2008 Percent 90%70%50%30%

15. Reviewing some counter-arguments  Is conditionality misunderstood?  Are policy makers constrained?  Is it possible to decide on a whole path?

16. Reviewing some pro-arguments  Is the reaction function better anchored?  Test 1:Are market rates reasonably aligned with our forecast?  Test 2: Are there smaller jumps in market rates around policy announcements?

17. a) November 2005 Baseline scenario Forward rates b) June 2006 c) June 2007 d) March 2008 Baseline scenario Forward rates Baseline scenario Forward rates Baseline scenario Forward rates

18. Change in 12-month LIBOR krone rate from the day of a policy announcement to the following day, and averages for the two periods. Basis points. Market rates as exogenous assumptions Interest rate forecasts

19.  Fewer misunderstandings  Easier to talk about the future  Exit strategy as integrated part of the communication  Credible interest rate forecast vs quantitative easing Reviewing some more pro-arguments

20. Challenges  Modelling optimal monetary policy  Consistency  Over time and accross states of the economy

21. Alternative approaches  Simple interest rate rule r t =  r t-1 + (1-  )[  1 (E t  t+k  -  * )+  2 y t +  3  y t ]  Optimal policy: Minimizing a loss function L = (π - π * ) 2 + λy 2 + δ(r - r -1 ) 2

22. Simple rule r t =  r t-1 + (1-  )[  1 (E t  t+k  -  * )+  2 y t +  3  y t ]  Two approaches  Coefficients optimized over unconditional loss  Coefficients optimized over conditional loss  We faced the “rules vs discretion” issue and had to take a stand!

23. Forward looking Taylor rule vs Timeless Inflation Output gap Interest rate Timeless MPR 2/2006 In 2006 we were able to reproduce our forward-looking Taylor-rule forecast with optimal policy under timeless perspective with the loss function:

24. Ramsey and Timeless (baseline scenario) Ramsey Timeless Ramsey Output gap Key policy rate Timeless Inflation

25. Timeless and Ramsey: - λ=0.30 - Weight change in interest rate=0.2 InflationOutput gap Key policy rate Timeless with different λ’s λ=0.20 Baseline scenario λ=0.40

26.  Current approach: Forecasts, alternative scenarios and ”interest rate account”  Publish loss function (Svensson)  Interest rate rule  Target criterion (Woodford&Giannoni) (π - π * ) + θ(y-y -1 )=0 Alternative approaches to commitment

27.  The experience is good  The conditionality and the uncertainty in the forecast seem well understood  Monetary policy appears to have become more predictable  The policy discussion is brought closer to the research frontier  Still early. If nothing else – better economists Conclusions

28. Communicating Monetary Policy Intentions - the Case of Norges Bank Amund Holmsen 16 May 2009 (with Jan F. Qvigstad, Øistein Røisland and Kristin Solberg-Johansen)