By Nicoletta Batini of the Bank’s Monetary Assessment and Strategy Division and Andrew Haldane of the Bank’s International Finance Division.
This article compares the use of simple backward-looking interest rate rules for monetary policy with policy rules that respond to forecasts of future inflation, in line with monetary policy behaviour in the real world. It appears that these forecast-based rules can better control both current and future inflation, by accounting for the lags in the monetary transmission mechanism, and can ensure a suitable degree of output-smoothing. In addition, they ensure that policy is responsive to most available information. Their superior performance provides support for the practice of basing monetary policy on forecasts of inflation and output, as in the United Kingdom.Monetary policy rules and inflation forecasts