Review of the ECB's strategy and alternative approaches.

• Position: European Central Bank, Jan F. Qvigstad

Speech by Chief Economist Jan F. Qvigstad at the conference "The ECB and Its Watchers VIII" in Frankfurt on 5 May 2006 Please note that the text may differ from the actual presentation.

1. Introduction

   Many years ago, central banking was a game of secrecy. The purpose of communication was not to be transparent, but indeed to divert people's attention from your true reaction pattern. Today, most central banks, including the ECB, consider transparency crucial. The ECB publicly announces its monetary policy strategy and regularly communicates its assessment of economic developments. Norges Bank goes even further than this by publishing its own interest rate forecast.

   If one asks the question: "What are the similarities and dissimilarities between the ECB and Norges Bank?", one should bear in mind what Alan Blinder and Charles Wyplosz said at the American Economic Association conference last year: "The appropriate volume and methods of central bank communication depend crucially on the nature of the monetary policy committee." (1) So what is useful and correct in Oslo may not be the best solution in Frankfurt. The MPCs are set up in different ways. There is not necessarily "one fit for all". I shall therefore explain what we do in Oslo in terms of communication and strategy and share with you our experiences so far. I will also comment on the ECB practices.

2. The forecast contingent on the central bank's own interest rate forecast

   When our MPC (2) decided to move forward and publish a forecast of the central bank's interest rate path, the decision was based on several arguments. One was the well established theoretical argument that monetary policy mainly works through expectations. Monetary policy is only effective if the central bank is able to influence interest rate expectations. Michael Woodford expressed this very clearly when he stated that monetary policy is the "management of expectations". "For not only do expectations about policy matter, but (...) very little else matters" (3)

   The central bank has an almost "one-to-one" impact on the shortest money market rates. The shortest rates, however, are of limited importance. How can central banks influence interest rate expectations? When inflation targeting was in its infancy, inflation targeters typically started out by assuming a constant interest rate (CIR) in their inflation reports. If the inflation forecast was above target at the announced time horizon, it was assumed that the central bank would raise interest rates. By the same logic, it is also possible to communicate indirectly to the market by basing forecasts on implied future interest rates in the market (MIR). For a long time, however, academics have advocated that central banks should publish forecasts based on the optimal interest rate path (OIR). Norges Bank does that now. We did not, however, make this move in one giant step. We moved gradually.

   The first step was taken in the beginning of 2003 when the MPC started to publish its monetary policy intentions for the next four months--the monetary policy strategy.

   The strategy includes an announced interval for the policy rate over the following four months until the next Inflation Report is released, conditional on economic developments that are broadly in line with our projections. The interval might in some sense be interpreted as the Bank's four-month forecast interval for the interest rate...