BPEA | 2002 No. 2

The Role of Models and Probabilities in the Monetary Policy Process

Discussants: Jeffrey Fuhrer and
Fuhrer headshot
Jeffrey Fuhrer Executive Vice President & Senior Policy Advisor - Federal Reserve Bank of Boston
Steven Durlauf

2002, No. 2

This is a paper on the way data relate to decisionmaking in central
banks. One component of the paper is based on a series of interviews
with staff members and a few policy committee members of four central
banks: the Swedish Riksbank, the European Central Bank (ECB), the
Bank of England, and the U.S. Federal Reserve. These interviews
focused on the policy process and sought to determine how forecasts
were made, how uncertainty was characterized and handled, and what
role formal economic models played in the process at each central bank.
In each of the four central banks, “subjective” forecasting, based on
data analysis by sectoral “experts,” plays an important role. At the Federal
Reserve, a seventeen-year record of model-based forecasts can be compared
with a longer record of subjective forecasts, and a second component
of this paper is an analysis of these records.
Two of the central banks—the Riksbank and the Bank of England—
have explicit inflation-targeting policies that require them to set quantitative
targets for inflation and to publish, several times a year, their
forecasts of inflation. A third component of the paper discusses the effects
of such a policy regime on the policy process and on the role of models
within it.