Anna Seim: The role of alternative scenarios in monetary policy communication

Since the flexible inflation targeting policy was adopted 30 years ago, the Riksbank has chosen a path characterised by high transparency. One reason for this is the Riksbank’s great independence, which entails a need for accountability that is facilitated by transparency, and another is related to the Riksbank’s efforts to guide expectations and pursue a predictable monetary policy.

The Riksbank is one of few central banks that publishes a forecast for its policy rate that reflects the majority view of the Executive Board. The Riksbank has been publishing policy rate forecasts for almost 20 years, and the overall experience has been good, according to Ms Seim.

“The policy rate forecast in the main scenario is consistent with our assessment of the economic outlook in general and our assessment of the long-run neutral interest rate. It is the Executive Board’s best estimate of the monetary policy we would pursue if events unfold as we foresee, i.e. if no new shocks hit the economy. But an important principle is that when a shock occurs, we revise the policy rate path to ensure that we attain the inflation target,” said Ms Seim.

Monetary policy decisions are always made under uncertainty, and therefore alternative scenarios can be valuable. The Riksbank has a long-standing tradition of working with and publishing alternative scenarios. They have been part of both our internal analysis and monetary policy communication for as long as the policy rate forecasts have been published.

“Since the only thing we can be sure of is that the future will not unfold as we expect, we complement the policy rate path with alternative scenarios. A key objective of these scenarios is to highlight important risks and to signal that policy may well deviate from the main scenario’s forecast for the policy rate. We want to guide economic agents and thus pave the way for alternative policy choices, should they be warranted.”

Working with scenarios has its challenges and testing empirically to what extent they actually make monetary policy more predictable is not straightforward. But Seim says they are still very useful, not least when uncertainty is unusually high.

“In more stable times, we can be more confident in our central projections. But when there is substantial uncertainty about where we are heading, it is natural to put more emphasis on ‘what ifs’. In terms of scenario design, it is not obvious how extreme or detailed they should be. But the closer we are to the main scenario, the more important it may be to describe in more detail the mechanisms and driving forces that we assess to be central.”

Read Anna Seim’s full speech here:
The Role of Alternative Scenarios in Monetary Policy Communication