Forecasting and Policy Making (Paper) - Center for Financial Studies

publication of the forecasts in the ECB’s monthly bulletin.
With regard to conditioning assumptions, national central bank staff and ECB staff decide on a
joint set of exogenous time paths for interest rates, exchange rates, the international environment and
fiscal variables. The projections are based on ”the technical assumption that three-month interest rates
in the euro area remain constant at the currently prevailing level over the horizon of the projection.
This assumption is made in order to illustrate the possible consequences of leaving monetary policy
unchanged over the projection horizon.” 8
Afterwards each national central bank computes a forecast for its country, whereas ECB staff pre-
pare a set of projections for the individual countries as well as for the euro area as a whole. The ECB’s
euro area projection is a consistent aggregation of its country assessments. The national central banks
use a variety of models, econometric methods and sectoral or country expertise. The combination of
model-based and judgemental-based information may also vary across countries.
Then an iterative process of consistency checking between the ECB’s area-wide forecast and the
aggregaton of the NCB forecasts is started. This process relies on meetings of NCB and ECB experts,
and importantly, also on analysis using the area-wide macroeconomic model of the ECB research
directorate. 9 In addition, consistency checks are conducted with respect to trade volumes and prices
as well as financial flows and consolidated balance sheets of monetary financial institutions in the euro
area.
The resulting euro system staff projections serve as an input about the current economic
situation and the outlook for future economic developments to the ECBs Governing Councils
meetings. The area-wide projections are published twice a year. The ECB’s staff publishes two
additional sets of forecasts to achieve a quarterly forecasting frequency. Forecasts of variables
that are published in the Monthly Bulletin include HICP inflation, real GDP growth and its main
components over a two-year horizon. The projections are published in the form of uncertainty ranges
corresponding to 75% probability bands. 10 Until 2008 this range has simply been equal to twice
the average absolute forecast error of past projections. Since 2008 Bayesian vector autoregression
models are used to compute predictive densities that are then reshaped to be compatible with the
euro system staff’s projections. From this density a range is derived that is comparable to the
ranges computed with the simpler method until 2008 (see Robertson et al., 2005, for details of the
methodology). Ranges are wider for longer forecast horizons reflecting the increased uncertainty.
The ranges reflect uncertainty due to unforeseeable shocks and imprecise parameter estimates as
well as departures from the conditioning assumptions of the baseline forecast. In addition specific
scenarios deviating from the baseline conditioning assumptions are computed. For example, euro
area system staff may compute a forecast where the growth rate for the United States is assumed
to be much lower than in the baseline case or where the oil price is assumed to be higher. Many
8 See European Central Bank (2001), page 7.
9 A description of the area-wide model is available in Fagan et al. (2005). In 2008 this model was replaced with a
New-Area-Wide model that is presented in Christoffel et al. (2008).
10 By contrast, the ranges of FOMC forecasts published by the Federal Reserve indicate the level of disagreement between
FOMC member point forecasts rather than economic uncertainty bands.
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