NÁRODNÁ BANKA SLOVENSKA BNB, April 23, 2008 Miroslav Gavura Forecasting and Policy Analysis System in the NBS

2008 April 23 BNB: Forecasting models and procedures of EU central banks Structure of the presentation Motivation – Stylized facts Organizational framework of FPAS Key Features of macroeconomic model Future challenges - projects

2008 April 23 BNB: Forecasting models and procedures of EU central banks Motivation – Stylized facts 3 periods of monetary-policy strategy in the NBS : Fixed exchange rate regime  Price stability through fixed exchange rate (band)  M2 – intermediate target : Orientation to qualitative conduct of monetary policy (MP)  Implicit inflation targeting  Managed floating current: Explicit inflation targeting  Inflation targeting in conditions of ERM II

2008 April 23 BNB: Forecasting models and procedures of EU central banks Motivation – Stylized facts MP3: Inflation target

2008 April 23 BNB: Forecasting models and procedures of EU central banks Motivation – Stylized facts Inflation Targeting Focus of MP on price stability – time lag between action and reaction of MP is longer than 1 year – Medium- term horizon Role of inflation expectation – important transmission channel Requirement of new forecasting and policy analysis system (FPAS)

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS - Required changes New organizational structure of forecasting process  Formalization of forecasting process  Formalization of forecasting team Development of new analytical tool – Quarterly projection model (QPM) Communication strategy  Medium-term forecast – main communication document  Focus on inflation forecast linked to inflation target  Risk analysis

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS – Implementation (2 years) May Technical assistance of the IMF  Two short visits of experts from the Czech National Bank  Focused on technical cooperation in model building (QPM) and efficient managing of the new forecasting process implementation Autumn Presentation of the model for discussion in the bank (structure and properties) Spring 2004 – internal forecasts using the model in Monetary policy department (for economists) July 2004 – presentation for the Bank Board  Structure and properties of the model  New forecasting process  Example of report (Medium-term forecast)

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS – Implementation 2nd half of 2004 – Testing phase  Two internal forecasting processes  Presented in the Board – not published December 2004 – Inflation targeting officially announced April 2005 – First publication of the Medium-term forecast  Presentation of the model and forecasting process for professional economists June 2005 – Conference on econometric modelling

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS – “Medium-term forecast” Key document for monetary-policy decisions and communication to public  Prepared on quarterly base  Publication version (  Analysis of current economic development  Estimation of current state of economy (cyclical part of economy)  Medium-term forecast of economy until 2008, focus on inflation forecast  Evaluation of risk analysis –inflation forecast in a form of Fan chart (8 quarters ahead)  Internal version - provides detailed information of forecast  Recommendation on interest rate trajectory  Detailed description of alternative scenarios

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS – organization of forecasting process Forecasting team  Head of forecasting team (member of the Board)  Coordinator of forecasting team  Forecasting team (12 experts) Forecasting process  6 weeks  6 regular working meetings + 2 meetings with the Board  Documentation  Reports  Archiving (common network disc – free access to documents)

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS – organization of forecasting process 3 chronologically subsequent sub- processes 1)Initial assumptions of forecast (exogenous environment) 2)Current position of economy and short-term forecast (3 quarters ahead) 3)Medium-term forecast until 2008 and risk analysis

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS – organization of forecasting process Meetings 1)Issue meeting 2)Initial assumptions 3)Short-term forecast (3Q ahead), equilibrium trends and current state of economy 4)Presentation of NTF to the Bank Board 5)Preparing medium-term forecast (iterative process) 6)Finalization of the medium-term forecast and alternative scenarios 7)Presentation of the Medium-term forecast 8)Post Mortem meeting

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS – key features of QPM (1) Gap model - modelling cyclical part of economy Description of transmission mechanism for small open economy Exogenous supply side – assumption of real convergence Systematic control of inflation through active monetary policy – modified Taylor rule Endogenous exchange rate Forward-looking components  Economic agents – inflation, exchange rate  Central bank – reaction function

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS – key features of QPM (2) Two separate blocks  Block of cyclical part of economy (QPM model)  describes transmission mechanism, impact of MP on economy and prices  Block of long-run equilibrium trends  Estimation of unobserved trend and cyclical variables form measured economic indicators on history using Multivariate Filter with Unobserved Components (MVF-UC)

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS – key features of QPM (3) Output gap RMCI Foreign inflation Nominal exchange rate Foreign Interest rate Domestic Interest rate Inflation Expectations Foreign Output gap Imported prices Inflation target

2008 April 23 BNB: Forecasting models and procedures of EU central banks FPAS – role of model in forecasting process Systematic control of inflation through active monetary policy – modified Taylor rule  Model provides information what is necessary to do in order for future to correspond with target Analytical tool useful both for purposes of projection and alternative scenarios  Different development of exogenous variables  Different intensity of economic mechanisms (e.g. effect of exchange rate) Possibility to evaluate main risk factors related to target

2008 April 23 BNB: Forecasting models and procedures of EU central banks Future challenges - Entry to Eurozone FPAS  Effort to increase compatibility with BMPE  BMPE versus internal forecasting exercise  Co-operation with ECB, CBs Modelling  MCM type model (AWM synthesis)  DSGE

2008 April 23 BNB: Forecasting models and procedures of EU central banks 2€1€ 50, 20, 10 c5, 2, 1 c THANK YOU FOR ATTENTION

2008 April 23 BNB: Forecasting models and procedures of EU central banks Motivation – Stylized facts Monetary policy Monetary programme – main document to the public  Once a year – at the end of previous year for the current year  focus on short-term horizon – forecast for one year ahead No complex econometric model  Forecast mostly based on judgmental approach  Simple regression methods (single equation models)